Skip to main content
Back Custom print Text Only Rich Text Print / Save as PDF
Download Original PDF

  • 1. Introduction

    • 1.1 Terminology

      1.1.1Abbreviations and other terms used in this paper have the following meanings:
       
       •“PD” means the probability of default of a counterparty over one year;
       
       •“LGD” means the loss incurred on a facility upon default of a counterparty relative to the amount outstanding at default;
       
       •“EAD” means the expected gross exposure of a facility upon default of a counterparty;
       
       •“Dilution risk” means the possibility that the amount of a receivable is reduced through cash or non-cash credits to the receivable’s obligor;
       
       •“EL” means the expected loss on a facility arising from the potential default of a counterparty or the dilution risk relative to EAD over one year;
       
       •“IRB Approach” means Internal Ratings-based approach;
       
       •“Foundation IRB Approach” means that, in applying the IRB framework, banks provide their own estimates of PD and use supervisory estimates of LGD and EAD, and, unless otherwise specified by the SAMA, are not required to take into account the effective maturity of credit facilities;
       
       •“Advanced IRB Approach” means that, in applying the IRB framework, banks use their own estimates of PD, LGD and EAD, and are required to take into account the effective maturity of the credit facilities;
       
       •A “borrower grade” means a category of creditworthiness to which borrowers are assigned on the basis of a specified and distinct set of rating criteria, from which estimates of PD are derived. The grade definition includes both a description of the degree of default risk typical for borrowers assigned the grade and the criteria used to distinguish that level of credit risk;
       
       •A “facility grade” means a category of loss severity in the event of default (as measured by LGD or EL) to which transactions are assigned on the basis of a specified and distinct set of rating criteria. The grade definition involves assessing the amount of collateral, and reviewing the term and structure of the transaction (such as the lending purpose, repayment structure and seniority of claims);
       
       •A “rating system” means all of the methods, processes, controls, and data collection and IT systems that support the assessment of credit risk, the assignment of internal risk ratings, and the quantification of default and loss estimates;
       
       •“Seasoning” means an expected change of risk parameters over the life of a credit exposure;
       
       •“VAR” means value-at-risk.
       

    • 1.2 Application

      1.2.1The requirements set out in this paper are applicable to locally incorporated banks, which use or intend to use the IRB Approach to measure capital changes for credit risk in KSA.
       
      1.2.2In the case of banks that are branches of foreign banking groups, all or part of their IRB systems may be centrally developed and monitored on a group basis. In applying the requirements of this paper, SAMA will consider the extent to which reliance can be placed on the work done at the group level. Where necessary, SAMA will co-ordinate with the home supervisors of those banking groups regarding the assessment of the comprehensiveness and integrity of the group- wide internal rating systems adopted by their authorized bank in Saudi Arabia. SAMA will also assess whether the relevant systems or models can adequately reflect the specific risk characteristics of the bank’ domestic portfolios.
       

    • 1.3 Background and Scope

      1.3.1The IRB Approach to the measurement of credit risk for capital adequacy purposes relies on banks’ internally generated inputs to the calculation of capital. To minimize the variation in the way in which the IRB Approach is carried out and to ensure significant comparability across banks, SAMA considers it necessary to establish minimum qualifying criteria concerning the comprehensiveness and integrity of the internal rating systems of banks adopting the IRB Approach. SAMA will employ these criteria for assessing their eligibility to use the IRB Approach.
       
      1.3.2This paper:
       
       prescribes the minimum requirements relating to risk quantification under the IRB Approach that a bank should comply with at the outset and on an ongoing basis if it were to use the IRB Approach to measure credit risk for capital adequacy purposes; and
       
       Sets out SAMA’s supervisory approach to circumstances where a bank is not in full compliance with the minimum requirements.
       
      1.3.3The minimum requirements set out herein apply to both the Foundation IRB Approach and the Advanced IRB Approach and to all asset classes1, unless stated otherwise.
       
      1.3.4The minimum requirements for risk quantification of equity exposures under the PD/LGD Approach are the same as those of the Foundation IRB Approach for corporate exposures, subject to the specifications set out in the Basel II document. The minimum requirements for adopting the internal models approach to calculation of capital charges for equity exposures are set out in section 8 below.
       
       The requirements for internal rating systems described in this paper should be read in conjunction with the “Minimum Requirements for Internal Rating Systems under IRB Approach”.
       

      1 Under the IRB Approach, assets are broadly categorized into five classes: (i) corporate (with specialized lending as a sub-class); (ii) sovereign; (iii) bank; (iv) retail; and (v) equity. Within the corporate and retail asset classes, a distinct treatment for purchased receivables may also apply provided certain conditions are met.