Part I. Credit Risk

Introduction

Guidance

(1) This chapter sets out the regulatory requirements in respect of managing the Credit Risk exposures of a Bank. Credit Risk refers to the risk of incurring losses due to failure on the part of a borrower or a counterparty to fulfil their obligations in respect of a financial transaction. This chapter aims to ensure that a Bank holds sufficient regulatory capital of a quality, acceptable to the AFSA, so that it can absorb unexpected losses arising out of its Credit Risk exposures, should the need arise and continue to operate in a sustainable manner.

(2) This chapter requires a Bank to:

1. (a) implement a comprehensive Credit Risk management framework to manage, measure and monitor Credit Risk commensurate with the nature, scale and complexity of its operations;
2. (b) calculate the Credit Risk Capital Requirement for its on-balance sheet and off- balance sheet credit exposures after adjusting for applicable levels of Credit Risk mitigation, according to the norms, methodologies, standards and guidance provided in the BPG issued by the AFSA;
3. (c) implement a sound framework for managing concentration risk and large exposures, including limits for concentration of such exposures to individual and group borrowers.

(3) This Chapter also deals with the following elements of determination of regulatory capital requirements to support a Bank’s Credit Risk exposures:

1. (a) the risk-weighted assets approach;
2. (b) Credit Risk Mitigation (CRM) techniques;
3. (c) provisioning requirements for impaired assets of the Bank.

(4) To guard against abuses and to address conflicts of interest, this Chapter requires transactions with related parties to be at arm’s length.

(5) The detailed requirements specifying the calculation methodologies, parameters, metrics and formulae in respect of the primary Credit Risk management and Credit Risk capital requirements outlined in this Chapter are provided in the Banking Prudential Guideline (BPG) issued by the AFSA. The BPG also provides detailed guidance on calculation methodologies, formulae, parameters and norms involved in calculation of Credit Risk capital requirements which is an element used to calculate the capital ratios for a Bank, as set out in Chapter 4 of BBR. It is suggested that this Chapter of the BBR, be read in conjunction with Chapter 5 of the BPG issued by the AFSA to facilitate understanding of the regulatory requirements and compliance with them.

5.1. Credit Risk Management – Systems and Controls

(1) A Bank must implement and maintain comprehensive Credit Risk management systems and controls which:

1. (a) are appropriate to the Bank’s type, scope, complexity and scale of operations;
2. (b) enable the Bank to effectively identify, assess, monitor, mitigate and control Credit Risk and to ensure that adequate Capital is available to support the Credit Risk exposures assumed; and
3. (c) ensure effective implementation of the Credit Risk strategy and policy.

(2) A Bank must:

1. (a) identify, assess, monitor, mitigate and, control its Credit Risk; and
2. (b) implement and maintain a prudent Credit Risk management policy which enables it to identify, assess, monitor, control and mitigate its Credit Risk.

(3) The Credit Risk management policy must:

1. (a) be documented and approved by its governing body;
2. (b) include the Bank’s risk appetite for Credit Risk;
3. (c) be appropriate to the nature, scale and complexity of its activities and for its risk profile;
4. (d) must establish procedures, systems, processes, controls and approaches to identify, measure, evaluate, manage and control or mitigate its Credit Risk and to ensure the integrity of its Credit Risk management;
5. (e) must set out the organizational structure, and must define the responsibilities and roles, for managing Credit Risk;
6. (f) ensure that its risk management framework including but not limited to tools, methodologies and, systems enable it to implement its Credit Risk management policy; and
7. (g) be reviewed and updated at a reasonable frequency, but at least on an annual basis.

(4) A Bank’s Credit Risk management policy must establish:

1. (a) a well-documented and effectively-implemented process for assuming Credit Risk that does not rely unduly on external credit assessments;
2. (b) well-defined criteria for approving credit (including prudent underwriting standards), and renewing, refinancing and restructuringexisting credit;
3. (c) a process for identifying the approving authority for credit, given its size and complexity;
4. (d) effective Credit Risk administration, including:
5. (i) regular analysis of counterparties’ ability and willingness to repay; and

(ii) monitoring of documents, legal covenants, contractual requirements, and collateral and other Credit Risk Mitigation techniques;

1. (e) effective systems for the accurate and timely identification, measurement, evaluation, management and control or mitigation of Credit Risk, and reporting to the Bank’s Governing Body and senior management;
2. (f) prudent and appropriate credit limits that are consistent with the Bank’s risk tolerance, risk profile and capital;
3. (g) provide for process and criteria for identification and recognition of problem assets as well as systems for measurement and reporting of problem assets;
4. (h) the criteria and responsibility for Credit Risk reporting, and the scope, manner and frequency of reporting, to the Governing Body or a committee of the governing body;
5. (i) establish, and must provide for the regular review of, the Bank’s Credit Risk tolerance and credit exposure limits to control credit exposures of the Bank;
6. (j) procedures for tracking and reporting exceptions to credit limits and deviations from Credit Risk management policies; and
7. (k) effective controls for the quality, reliability and relevance of data and validation procedures. Note Guidance in respect of the contents of a Bank’s Credit Risk management policy which is required to satisfy the regulatory requirement in the Rule 5.1 is provided in Chapter 5 of the BPG issued by the AFSA.

(5) A Bank’s Credit Risk management policy must ensure that credit decisions are free of conflicts of interest and are made on an arm’s-length basis. In particular, the credit approval and credit review functions must be independent of the credit initiation function.

(6) A Bank’s Credit Risk management policy must provide for monitoring the total indebtedness of each counterparty and any risk factors that might result in default (including any significant unhedged foreign exchange risk).

(7) A Bank must give the AFSA full access to information about its credit portfolio. The Bank must also give the AFSA access to staff involved in assuming, managing, controlling and reporting on Credit Risk.

(8) The Credit Risk management policy must enable the Bank to carry out stress-tests on its credit portfolio at intervals appropriate for the nature, scale and complexity of the Bank’s business and using various scenarios based on appropriate assumptions. The policy must take into account the Bank’s Credit Risk profile (including on-balance-sheet and off-balance-sheet exposures) and tolerance in the context of the markets and macroeconomic conditions in which the Bank operates. The Bank’s Credit Risk stress testing must include procedures to make any changes to its Credit Risk management framework based on the results from the stress testing. Note Guidance in respect of a Bank’s policies for Credit Risk assessment which is required to satisfy the regulatory requirement in the Rule 5.1 is provided in paragraphs 10 and 11 of Chapter 5 of the BPG issued by the AFSA.

5.2. Role of Governing Body—Credit Risk

(1) A Bank’s Governing Body must ensure that its Credit Risk management policy enables it to obtain a comprehensive bank-wide view of its Credit Risk exposures and covers the full credit lifecycle including credit underwriting, credit evaluation, and the Credit Risk management of the Bank’s trading activities.

(2) A Bank must ensure that its Governing Body is responsible for monitoring the nature and level of Credit Risk assumed by it and for monitoring the Credit Risk management process.

(3) The Governing Body of the Bank must also ensure that:

• (a) an appropriate senior management structure with clearly defined responsibilities and roles for Credit Risk management and for compliance with the Bank’s Risk strategy, is established and maintained;
• (b) the Credit Risk management framework is consistent with the Bank’s risk profile and its systemic importance.
• (c) the Bank’s senior management and other relevant staff have the necessary experience to manage Credit Risk and to effectively implement the Credit Risk management policy;
• (d) appropriate Credit limits covering Credit Risk management in both day-to-day and stressed conditions are set;
• (e) stress-tests, funding strategies, contingency funding plans and holdings of high-quality liquid assets are effective and appropriate for the Bank;
• (f) the Bank’s senior management:

(i) develops a Credit Risk management policy in accordance with the Bank’s Credit Risk tolerance;

(ii) monitors the Bank’s Credit Risk profile and reports to the Governing Body regularly;

(iii) determines, and sets out in the Bank’s Credit Risk management policy, the structure, responsibilities and controls for managing Credit Risk and for overseeing the Credit Risk of all legal entities, branches and subsidiaries in the jurisdictions in which the Bank is active; and

(iv) monitors trends and market developments that could present significant, unprecedented or complex challenges for managing Credit Risk so that appropriate and timely changes to the Credit Risk management policy can be made.

(4) The Governing Body must regularly review reports on the Bank’s Credit Risk profile and portfolio returns and, where necessary, information on new or emerging problem assets. The Governing Body of the Bank must also review the Credit Risk tolerance and strategy at least on an annual basis.

(5) The Governing Body must approve:

• (a) the Bank’s Credit Risk management policy; and
• (b) its Credit Risk tolerance and risk strategy.

5.3. Classification of Credit exposures

(1) Unless a Bank has established something more detailed, the Bank must classify credits into 1 of the 5 categories in table 5A. Nothing in the table prevents a Bank from classifying a credit under a higher risk category than the table requires.

(2) Unless there is good reason not to do so, the same category must be given to all credit exposures to the same counterparty.

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5.4. Problem Assets and Impaired Assets

(1) A Bank’s Credit Risk management policy must facilitate the Bank’s collection of past-due obligations, and its management of problem assets through:

• (a) monitoring of their credit quality;
• (b) early identification and ongoing oversight; and
• (c) review of their classification, provisioning and write-offs.

(2) The refinancing of a special mention or impaired credit must not be used to reclassify the credit to a more favourable category.

(3) The AFSA may require a special mention credit to be managed individually, and may set a higher level of provision for the credit, if the AFSA is of the view that market circumstances or any other industry-related concerns require such action.

5.5. Using ratings from External Credit Rating Agencies (ECRAs)

(1) A Bank must use only a solicited Credit Risk rating determined by an ECRA in determining the riskweights for the Bank’s exposures. The Bank must use the ratings determined by an ECRA consistently and in accordance with these rules and its Credit Risk management policy.

(2) If there is only one assessment by an ECRA for a particular claim or asset, that assessment must be used to determine the risk-weight of the claim or asset. If there are two assessments by ECRAs and the assessments map into different risk weights, the higher risk-weight must be applied. If there are three or more assessments with 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.

(3) If a Bank invests in an instrument with an issue-specific rating, the risk-weight to be applied to the instrument must be based on that rating.

(4) If the Bank invests in an unrated instrument and the issuer of the instrument is assigned a rating that results in a lower risk-weight than the risk-weight normally applied to an unrated position, the Bank may apply the lower risk-weight to the instrument but only if the claim for the instrument has the same priority as, or is senior to, the claims to which the issuer rating relates. If the instrument is junior to the claims to which the issuer rating relates, the Bank must apply the risk-weight normally applied to an unrated position.

(5) If the Bank invests in an unrated instrument and the issuer of the instrument is assigned a rating that results in a higher risk-weight than the risk-weight normally applied to an unrated position, the Bank must apply the higher risk-weight to the instrument if the claim for that instrument has the same priority as, or is junior to, the claims to which the issuer rating relates.

(6) A Bank must not use a Credit Risk rating for one entity in a Financial Group to determine the riskweight for an unrated entity in the same Financial Group. If the rated entity has guaranteed the unrated entity’s exposure to the Bank, the guarantee may be recognised for risk- weighting purposes if it satisfies the criteria set out in this Chapter on Guarantees.

(7) If an issuer rating is assigned to a counterparty and a Bank applies a risk-weight to an unrated position based on the rating of anequivalent exposure to the same counterparty:

• (a) the Bank must use that counterparty’s domestic-currency rating for any exposure denominated in the currency of the counterparty’s place of residence or incorporation; and
• (b) the Bank must use that counterparty’s foreign-currency rating for any exposure denominated in a foreign currency.

(8) A short-term Credit Risk rating must be used only for short-term claims relating to banks and corporations (such as those arising from the issuance of commercial paper). The rating is taken to be issue-specific and must be used only to assign risk-weights for claims arising from a rated facility.

(9) If a short-term rated exposure is assigned a risk-weight of 50%, an unrated short-term exposure to the same counterparty cannot be assigned a risk-weight lower than 100%. If a short-term facility of an issuer is assigned a risk-weight of 150% based on the facility’s Credit Risk rating, all unrated claims of the issuer (whether long-term or short-term) must be assigned a risk-weight of 150%.

5.6. Calculation of Risk-Weighted Assets (RWAs)

(1) A Bank must apply risk-weights to all of its on-balance-sheet and off-balance-sheet asset items using the Risk-Weighted Assets method, defined in this Rule.

(2) If a claim or asset to which a risk-weight must be applied by a Bank is secured by eligible financial collateral or a guarantee (or there is mortgage indemnity insurance, or a credit derivative instrument or netting agreement), the Credit Risk Mitigation techniques allowed in this Chapter may be used to reduce the Bank’s Credit Risk capital requirement.

(3) A Bank must not rely only on a rating determined by an ECRA to assess the risks associated with an exposure. The Bank must also carry out its own Credit Risk assessment of each exposure (rated or unrated) to determine whether the risk-weights applied to each of them are appropriate. The determination must be based on each exposure’s inherent risk.

(4) If there are reasonable grounds to believe that the inherent risk of an exposure is significantly higher than that implied by the risk weight assigned to it, the Bank must consider the higher risk (and apply a higher risk-weight) in calculating the Credit Risk capital requirement.

(5) A Bank must take into account all commitments in calculating its Credit Risk capital requirement, whether or not those commitments contain material adverse change clauses or other provisions that are intended to relieve the Bank of its obligations under particular conditions.

(6) Notwithstanding the provisions of these rules, the AFSA may determine the risk-weighted amount of a particular on-balance-sheet or off-balance-sheet Exposure of a Bank, if the AFSA considers that the Bank has not risk-weighted the Exposure appropriately. Such a determination must be issued by the AFSA, in writing.

(7) The AFSA may also impose specific capital requirements or limits on significant risk exposures, including those that the AFSA considers have not been adequately transferred or mitigated.

5.7. Calculation of RWAs – for On-Balance Sheet Exposures

(1) A Bank’s total RWAs for its on-balance-sheet items must be calculated as the sum of the riskweighted amounts of each of its on balance-sheet items.

(2) The RWA of an on-balance-sheet item must be calculated by multiplying its exposure (after taking into account any applicable Credit Risk Mitigation) by the applicable risk-weight in table 5B.

(3) If column 3 of table 5B states that the risk weight is “based on ECRA rating” for a particular asset, the applicable risk-weight for that asset item must be derived from the table 5C. If a claim or asset’s risk-weight is to be based on the ECRA rating and there is no such rating from an ECRA, the Bank must apply the risk-weight in the last column of table 5C.

Table 5B Risk-weights for on-balance-sheet items

Table 5C Risk-weights based on ratings determined by ECRAs

Note In table 5C, the ratings are shown according to Standard & Poor’s conventions. If a claim or asset is not rated by Standard & Poor’s, its rating must be mapped to the equivalent Standard & Poor’s rating.

5.8. Specialised lending

A specialised lending exposure is risk-weighted one rating less favourable than the rating that would apply, under table 5C, to the counterparty to the transaction (or to the party to whom that counterparty has the right of recourse).

5.9. Risk-weights for unsecured part of claim that is past due for more than 90 days

(1) The risk-weight for the unsecured part of a claim (other than a claim secured by an eligible residential mortgage) that is past due for more than 90 days is:

• (a) 150% if the specific provisions are less than 20% of the past due claim;
• (b) 100% if the specific provisions are 20% or more, but less than 50%, of the past due claim; or
• (c) 50% if the specific provisions are 50% or more of the past due claim.

(2) The risk-weight for the unsecured part of a claim secured by an eligible residential mortgage that is past due for more than 90 days is:

• (a) 100% if the specific provisions are less than 20% of the past due claim; or
• (b) 50% if the specific provisions are 20% or more of the past due claim.

5.10. Calculation of RWAs – for Off-Balance Sheet Exposures

(1) A Bank’s total risk-weighted off-balance-sheet items is the sum of the risk-weighted amounts of its market-related and non- market-related off-balance-sheet items. An off-balance-sheet item must be converted to a credit equivalent amount before it can be risk- weighted.

(2) The risk-weighted amount of an off-balance-sheet item is calculated using the following steps in the same sequence:

• (a) convert the notional principal amount of the item to its on-balance-sheet equivalent (credit equivalent amount).
• (b) multiply the resulting credit equivalent amount by the risk-weight in table 5B or 5C, as applicable to the claim or asset.

(3) A Bank must include derivatives and all market-related off-balance-sheet items (including onbalance-sheet unrealised gains on market-related off-balance-sheet items) in calculating its riskweighted credit exposures. A market-related item must be valued at its current market price.

5.11. Credit equivalent amounts for market-related items

(1) A Bank must calculate the credit equivalent amount of each of its market-related items. Unless the item is covered by an eligible netting agreement, the credit equivalent amount of a market- related off-balance-sheet item is the sum of the current credit exposure and the potential future credit exposure from the item.

(2) The procedure, formula and the credit conversion factors for this rule are provided in Section E (14) of Chapter 5 of the BPG.

(3) Potential future credit exposure must be based on an effective, rather than an apparent, notional principal amount. If the stated notional principal amount of an item is leveraged or enhanced by the structure of the item, the Bank must use the effective notional principal amount in calculating the potential future credit exposure. No potential future credit exposure is calculated for a singlecurrency floating/floating interest rate swap. The credit exposure from such an interest rate swap must be based on mark-to-market values.

5.12. Calculation of credit equivalent amounts

(1) Credit conversion factors for items with terms subject to reset: In case of an item structured to settle outstanding exposures after specified payment dates on which the terms are reset (that is, the mark- to-market value of the item becomes zero on the specified dates), the period up to the next reset date must be taken as the item’s residual maturity. For an interest rate item of that kind that is taken to have a residual maturity of more than 1 year, the credit conversion factor to be applied must not be less than 0.5% even if there are reset dates of a shorter maturity. For an item with 2 or more exchanges of principal, the credit conversion factor must be multiplied by the number of remaining exchanges under the item.

(2) The procedure, formula and the credit conversion factors for the calculation of risk-weighted assets for single-name swaps are detailed in Section E (15) of Chapter 5 of the BPG.

(3) A Bank must calculate the credit equivalent amount of each of its non-market-related items. The procedure, formula and the credit conversion factors for the calculation of risk-weighted assets for single-name swaps are detailed in Section E (16) of Chapter 5 of the BPG.

(4) In calculating the credit equivalent amount of a non-market-related off- balance-sheet item that is an undrawn (or partly drawn) commitment, a Bank must use the undrawn amount of the commitment.

(5) For an irrevocable commitment to provide an off-balance-sheet facility, the original maturity must be taken to be the period from the commencement of the commitment until the associated facility expires.

5.13. Policies—foreign exchange rollovers

(1) A Bank must have policies for entering into and monitoring rollovers on foreign exchange transactions and the policies must restrict the Bank’s capacity to enter into such rollovers. The Bank must notify the AFSA if it enters into a rollover in breach of its policy. Such rollovers must be approved by the Governing Body of the Bank. The AFSA may direct how the rollover is to be treated for capital adequacy purposes.

(2) A Bank should have systems and controls to identify, monitor, control and report off-market transactions.

(3) A Bank must not enter into a transaction at an off-market price, unless the transaction is a historical rate rollover on a foreign exchange transaction. A historical rate rollover on a foreign exchange transaction may be entered into at an off-market price (instead of current market price).

Credit Risk Mitigation

5.14 Requirements—Credit Risk Mitigation techniques

(1) A Bank’s Credit Risk management policy must set out the conditions under which Credit Risk Mitigation techniques may be used. The policy must enable the Bank to manage Credit Risk Mitigation techniques and the risks associated with their use.

(2) The Bank must analyse the protection given by Credit Risk Mitigation techniques to ensure that any residual Credit Risk is identified, measured, evaluated, managed and controlled or mitigated. If the Bank accepts collateral, its policy must state the types of collateral that it will accept, and the basis and procedures for valuing collateral.

(3) If the Bank uses netting agreements, it must have a netting policy that sets out its approach. The netting policy must provide for monitoring netting agreements and must enable the Bank to monitor and report netted transactions on both gross and net bases.

(4) To obtain capital relief, the Credit Risk Mitigation technique and every document giving effect to it must be binding on all parties and enforceable in all the relevant jurisdictions. A Bank must review the enforceability of a Credit Risk Mitigation technique that it uses. The Bank must have a wellfounded legal basis for any conclusion about enforceability and must carry out further reviews to ensure that the technique remains enforceable.

(5) The effects of a Credit Risk Mitigation technique must not be double-counted. The Bank is not allowed to obtain capital relief if:

• (a) the risk-weight for the claim or asset is based on an issue-specific rating; and
• (b) the ECRA that determined the rating had taken the technique into consideration in doing so.

5.15. Standard haircuts for Credit Risk Mitigation calculations

(1) A Bank must use the standard haircuts (expressed in percentages) set out in this rule in any calculation relating to Credit Risk mitigation. The haircuts are applied after risk mitigation to calculate adjusted exposures and are intended to take into account possible future price fluctuations.

(2) In table 5 D: other issuers include banks, corporates, and public sector enterprises that are not treated as sovereigns. sovereign includes a multilateral development bank, and a non- commercial public sector enterprise, that has a zero per cent risk-weight.

Table 5 D Haircuts for debt securities

Note Table 5 D item 3, column 5: securities rated BB+ or below are eligible financial collateral only if issued by a sovereign or non commercial public sector enterprise—see Rule 5.17 (1) (c) (i).

Table 5 E Haircuts for other instruments

(3) The procedure, formulas and the methods for the calculation of haircuts for Credit Risk Mitigation techniques with various types of currency mismatches are detailed in Section F (8 to 10) of Chapter 5 of the BPG.

5.16. Collateral

(1) A Bank is able to obtain capital relief by accepting collateral only if the collateral is eligible financial collateral. Collateral may be lodged by the counterparty of the Bank holding a credit exposure (or by a third party on behalf of the counterparty). If collateral is lodged by a third party, the third party must guarantee the counterparty’s obligation to the Bank and must indemnify the Bank if the counterparty fails to fulfil its obligation. The Bank must ensure that the guarantee does not fail for lack of consideration.

(2) The Bank must enter into a written agreement with the party lodging the collateral. The agreement must establish the Bank’s direct, explicit, irrevocable and unconditional recourse to the collateral. The mechanism by which collateral is lodged must allow the Bank to liquidate or take possession of the collateral in a timely way. The Bank must take all steps necessary to satisfy the legal requirements applicable to its interest in the collateral.

(3) There must not be a significant positive correlation between the value of the collateral and the credit quality of the borrower.

5.17. Eligible financial collateral

(1) The following are eligible financial collateral if they satisfy the criteria in sub-rule (2):

1. (a) gold bullion;
2. (b) cash;
3. (c) debt securities that are assigned, by an ECRA, a rating of:
4. (i) for sovereign or non-commercial public-sector enterprise securities that are eligible for zero per cent risk-weight—at least BB-;
5. (ii) for short-term debt securities—at least A-3/P-3; or
6. (iii) for any other securities—at least BBB-;
7. (d) subject to sub-rule (3), debt securities that have not been assigned a rating by an ECRA if:
8. (i) the securities are issued by a bank (in or outside the AIFC) as senior debt and are listed on a regulated exchange;
9. (ii) all rated issues of the same seniority issued by the bank have a credit rating of at least BBB-(for long-term debt instruments) or A-3/P-3 (for short-term debt instruments); and
10. (iii) the Bank and the holder of the collateral have no information suggesting that the securities should have a rating below BBB- or A-3/P-3;
11. (e) equities (including convertible bonds) that are included in a main index;
12. (f) tracker funds, mutual funds and undertakings for collective investments in transferable securities (UCITS) if:
13. (i) a price for the units is publicly quoted daily; and
14. (ii) the funds or UCITS are limited to investing in instruments listed in this sub-rule;
15. (g) equities (including convertible bonds) that are not included in a main index but are listed on a regulated exchange, and funds and UCITS described in paragraph (f) that include such equities.

(2) For collateral to be eligible financial collateral, it must be lodged for at least the life of the exposure and must be marked-to-market at least once a month. The release of collateral must be conditional on the repayment of the exposure, but collateral may be reduced in proportion to the amount of any reduction in the exposure.

(3) Collateral in the form of securities issued by the counterparty or a person connected to the counterparty is not eligible financial collateral. Insurance contracts, put options, and forward sales contracts or agreements are not eligible financial collateral.

(4) Cash collateral, in relation to a credit exposure, means collateral in the form of:

1. (a) notes and coins;
2. (b) certificates of deposit, bank bills and similar instruments issued by the Bank holding the exposure; or
3. (c) cash-funded credit-linked notes issued by a Bank against exposures in its Banking Book, if the notes satisfy the criterion for credit derivatives in Rule 5.19(2).

(5) Eligible financial collateral must be held by:

1. (a) the Bank;
2. (b) a branch (in or outside the AIFC) of the Bank;
3. (c) an entity that is a member of the financial group of which the Bank is a member;
4. (d) an independent custodian; or
5. (e) a central counterparty.

(6) The holder of cash collateral in the form of a certificate of deposit or bank bill issued by a Bank must keep possession of the instrument while the collateralised exposure exists. If the collateral is held by an independent custodian or central counterparty, the Bank must take reasonable steps to ensure that the holder segregates the collateral from the holder’s own assets.

(7) If collateral is held by a branch of a Bank and the branch is outside the AIFC, the agreement between the Bank and the party lodging the collateral must require the branch to act in accordance with the agreement. Risk-weight for cash collateral

(8) A Bank may apply a zero per cent risk-weight to cash collateral if the collateral is held by the Bank itself. The Bank may apply a zero per cent risk-weight to cash collateral held by another member of the financial group of which the Bank is a member if the agreement between the Bank and the party lodging the collateral requires the holder of the collateral to act in accordance with the agreement.

(9) If cash collateral is held by a bank under a non-custodial arrangement, and the collateral is lodged with the Bank under an agreement that establishes the Bank’s irrevocable and unconditional recourse to the collateral, the exposure covered by the collateral (after any necessary haircuts for currency risk) may be assigned the risk-weight of the bank.

(10) If cash collateral is held by an independent custodian (other than a central counterparty), the riskweight of the holder of the collateral must be used. However, the Bank may apply a zero per cent risk-weight to notes and coins held by an independent custodian.

(11) The secured part of a claim must be risk-weighted at whichever is the higher of 20% or the riskweight applicable to the eligible financial collateral. However, a risk-weight lower than 20% may be applied to the secured part if Rule 5.17(12) applies. The unsecured part of the claim must be weighted at the risk-weight applicable to the original counterparty.

(12) A zero per cent risk-weight may be applied to a collateralised transaction if:

1. (a) there is no currency mismatch; and
2. (b) any one of the following applies:
3. (i) the collateral is in the form of sovereign securities that are eligible for zero per cent risk-weight;
4. (ii) the collateral is in the form of cash collateral on deposit with the Bank; or
5. (iii) if the collateral is in the form of non-commercial public sector enterprise securities:

(A) the securities are eligible for zero per cent risk-weight; and

(B) the market value of the collateral has been discounted by 20%.

(13) A 0 % risk-weight may be applied to an OTC derivative transaction if there is no currency mismatch and the transaction is fully collateralised by cash and marked-to-market daily.

(14) A 10% risk-weight may be applied to an over the counter derivative transaction to the extent that the transaction is collateralised by sovereign or non-commercial public sector enterprise securities that are eligible for 0 % risk-weight.

5.18. Guarantees

(1) Capital relief is allowed from a guarantee if the guarantor is an eligible guarantor and the guarantee satisfies the criteria in sub-rules (2) to (4). Before accepting a guarantee, a Bank must consider the legal and financial ability of the guarantor to fulfil the guarantee.

(2) A guarantee must be a direct claim on the guarantor and must clearly state the extent of the cover. A letter of comfort is not a guarantee for the purposes of this Division.

(3) A guarantee must be irrevocable and unconditional. It must not include a term or condition:

• (a) that allows the guarantor to cancel it unilaterally; or
• (b) that increases the effective cost of cover if the credit quality of the guaranteed exposure deteriorates; or
• (c) that allows the guarantor not to indemnify the Bank in a timely way if the counterparty defaults.

(4) If a claim on a counterparty is secured by a guarantee, the part of the claim that is covered by the guarantee may be weighted at the risk- weight applicable to the guarantor. The unsecured part of the claim must be weighted at the risk-weight applicable to the original counterparty. Eligible guarantors

(5) Eligible guarantor means:

• (a) the Republic of Kazakhstan or any other sovereign;
• (b) an entity that is treated as a sovereign in accordance with the Basel Accords; or
• (c) a public sector enterprise or other entity that has:
• (i) a risk-weight of 20% or lower; and
• (ii) a lower risk-weight than the counterparty.

(6) A parent entity, Subsidiary or affiliate of a counterparty may be an eligible guarantor if it has a lower risk-weight than the counterparty.

5.19 Credit derivatives

(1) Capital relief is allowed if a Bank uses an eligible credit derivative. Each of the following is an eligible credit derivative if it satisfies sub-rule (2):

• (a) a single-name credit-default swap;
• (b) a total-rate-of-return swap for which the Bank has recorded any deterioration in the value of the underlying exposure, in addition to recording the net payments received on the swap as net income;
• (c) a cash-funded credit-linked note;
• (d) a first and second-to-default credit derivative basket product.

(2) The credit derivative must not include a term or condition that terminates the credit protection, or increases the Bank’s costs for the protection, if the credit quality of the underlying exposure deteriorates.

(3) If a claim on a counterparty is protected by a credit derivative, the part of the claim that is protected may be weighted at the risk weight applicable to the issuer of the credit derivative. The unprotected part of the claim must be weighted at the risk-weight applicable to the original counterparty.

5.20. Netting agreements

(1) A Bank is able to obtain capital relief from a netting agreement with a counterparty only if the agreement is an eligible netting agreement. A Bank that has entered into a netting agreement must consistently net all the transactions included in the agreement. The Bank must not selectively pick which transactions to net.

(2) The eligibility criteria, conditions for enforceability, procedures, and the methods for the use of netting agreements as a Credit Risk mitigant to avail of eligible capital relief are detailed in Section G of Chapter 5 of the BPG. In order to avail of capital relief by using netting agreements to mitigate Credit Risk, a Bank is expected to fully comply with the provisions detailed in Section G of Chapter 5 of the BPG. Failure to do so, would be seen as attempts to unduly overstate the capital position of the Bank.

5.21. Securitisation and Re-securitisation

(1) The Part sets out the framework for determining a Bank’s minimum capital requirement to cover the Bank’s exposures arising from traditional and synthetic securitisations.

(2) The background and description of the use of securitisation to obtain capital relief as well as to ensure appropriate risk-weighting of securitisation positions held by a Bank, eligibility criteria, conditions for enforceability, procedures, and the methods for the capital treatment of securitisation and re-securitisation are detailed in Section H of Chapter 5 of the BPG. In order to avail of capital relief while using securitisation or to ensure that the securitisation positions are appropriately riskweighted, a Bank is expected to fully comply with the provisions detailed in Section H of Chapter 5 of the BPG. Failure to do so, would be seen as attempts to unduly overstate the capital position of the Bank.

5.22. Provisioning requirements

(1) Provisioning means setting aside an amount to cover expected losses on special mention credits, impaired credits and other problem assets, based on loan-loss probability. Provisioning is made before profit is earned.

5.23. Transactions with related parties

(1) The detailed requirements specifying the description, additional clarifications on definition of related parties, methodologies, parameters, and controls formulae in respect of the primary regulations on related party transactions are provided in Section J of Chapter 5 of the Baking Prudential Guideline (BPG) issued by the AFSA. It is suggested that this rule on related party transactions, be read in conjunction with Chapter 5 of the BPG issued by the AFSA to facilitate understanding of the regulatory requirements and compliance with them.

Part II Concentration risk and related matters

5.24 General

(1) This Chapter sets out the requirements for a Bank’s policy to identify, measure, evaluate, manage and control or mitigate concentrations of Credit Risk exposures. This Chapter also sets limits on a Bank’s Credit Risk exposures to individual counterparties and to groups of connected counterparties.

(2) The detailed requirements for managing the concentration risk including but not limited to methodologies, guidance, eligibility criteria, terms, parameters, and formulae which are required to comply with the primary regulations addressing concentration risk management and related regulatory limits outlined in this Part II of Chapter 5 of BBR are provided in section K of Chapter 5 of the Banking Prudential Guideline (BPG) issued by the AFSA. The relevant sections of the BPG also provide the supervisory expectations of the AFSA in relation to management of concentration risk.

(3) Banks are expected to comply with the provisions outlined in Section K of Chapter 5 of the BPG, in order to ensure compliance with the rules in this Part II. Failure to do so, would be assessed by the AFSA as inadequate risk management and governance implying non compliance with basic regulatory requirements applicable to Banks. It is suggested that this Chapter of the BBR, be read in conjunction with Chapter 5 of the BPG issued by the AFSA to facilitate understanding of the regulatory requirements and compliance with them.

5.25 Concentration risk

(1) Concentration risk to a Bank arises if the Bank is exposed to 1 counterparty, or to 2 or more counterparties that are not truly independent of each other, and the total of the exposures to the counterparty or counterparties is large enough to endanger the Bank’s liquidity or solvency.

5.26. Management of Concentration risk exposures

Calculating exposures

(1) Large exposure means a gross exposure to a counterparty or connected counterparties that is 10% or more of the Bank’s regulatory capital. In this rule: gross exposure to a counterparty or connected counterparties is the total of the following exposures:

• (a) on-balance-sheet and off-balance-sheet exposures;
• (b) debt securities held by the Bank;
• (c) equity exposures.

(2) In calculating the gross exposure, a Bank must include:

• (a) the outstanding balances of all loans and advances, including balances with other banks;
• (b) holdings of debt or equity securities;
• (c) unused off-balance-sheet commitments, whether revocable or irrevocable; and
• (d) the credit equivalent amounts of all market-related transactions (calculated in accordance with the rules in this Chapter).

(3) However, in calculating the gross exposure, a Bank must not include:

• (a) claims, equity investments and other exposures deducted from the Bank’s capital;
• (b) exposures arising in the course of settlement of market-related contracts; and
• (c) exposures that have been written off.

(4) For this Part II:

• (a) a Bank must treat an exposure as reduced (to the extent permitted by the provisions on Credit Risk Mitigation in part I of this chapter) by any applicable Credit Risk Mitigation technique; and
• (b) a Bank that is part of a financial group may offset intragroup amounts due to other deposit takers within the group.

5.27 Powers of the AFSA

(1) If the AFSA considers it necessary or desirable to do so in the interest of effective supervision of a Bank, the AFSA may direct the Bank to treat a party as connected to another party.