| 5.1 | Banks can choose between two broad methodologies for calculating their risk-based capital requirements for credit risk. The first is the standardized approach, which is set out in chapters 6 to 9:
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| | i. | The standardized approach assigns standardized risk weights to exposures as described in chapter 7. Risk weighted assets are calculated as the product of the standardized risk weights and the exposure amount. Exposures should be risk-weighted net of specific provisions (including partial write-offs).
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| | ii. | To determine the risk weights in the standardized approach for certain exposure classes, banks may, as a starting point, use assessments by external credit assessment institutions (ECAIs) that are recognized as eligible for capital purposes by SAMA. The requirements covering the use of external ratings are set out in chapter 8.1
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| | iii. | The credit risk mitigation techniques that are permitted to be recognized under the standardized approach are set out in chapter 9.
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| 5.2 | The second risk-weighted assets approach is the internal ratings-based (IRB) approach, which allows banks to use their internal rating systems for credit risk. The IRB approach is set out in chapters 10 to 16. Banks must seek SAMA’s regulatory approval before they can use the IRB Approach for calculation of capital requirements for credit risk, subject to the Bank meeting all minimum requirements for the use of IRB Approach, supervisory review and validation exercise as may be carried out by SAMA.
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| 5.3 | This policy document also covers the treatment in banking book of the following exposures:
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| | 1. | Securitization exposures (chapters 18 to 23);
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| | 2. | Equity investments in funds (chapter 24); and
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| | 3. | Exposures arising from unsettled transactions and failed trades (chapter 25).
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1 The notations in chapters 7 to 9 follow the methodology used by one institution, Standard and Poor’s (S&P). The use of S&P 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.
