7.2. Market-based Approach (MBA) and PD/LGD Approach
[341] Supervisors may choose any of the two Approaches - MBA or a PD/LGD Approach - would be used by a Banks to calculate risk-weighted assets for equity exposures not held in the trading book. The PD/LGD Approach is designed to capture risks from credit-related losses only; this approach is more suited for use in cases where credit-related issues are seen as the main focus. The MBA is designed to capture a wide range of risks (e.g., interest rates, general market movements, etc), in addition to credit-related losses.
SAMA proposes that the MBA should be used for determining capital requirements for equity exposures in the banking book.
7.2.1 MBA Based Approach
Under the market-based approach, institutions are permitted to calculate the minimum capital requirements for their banking book equity holdings using one or both of two separate and distinct methods: a simple risk weight method or an internal models method.
The method used should be consistent with the amount and complexity of the institution’s equity holdings and commensurate with the overall size and sophistication of the institution.
Supervisors may require the use of either method based on the individual circumstances of an institution.
(Refer para 343, International Convergence of Capital Measurement and Capital Standards – June 2006)
• Under the simple risk weight method, a 300% risk weight to be applied to publicly traded, and 400% for all others.
• If an internal model is used, minimum quantitative and qualitative requirements would have to be met on an ongoing basis, including a minimum capital charge be no less than the capital charge that would be calculated under the simple approach at a risk weight of 200% for publicly traded, and 300% for other equities.
7.2.2 PD/LGD Approach
The minimum requirements and methodology for the PD/LGD approach for equity exposures are the same as those for the IRB foundation approach for corporate exposures subject to some constraints. These include the bank’s estimate of the PD of a corporate entity in which it holds an equity position must satisfy the same requirements as the bank estimate of the PD of a corporate entity where the bank holds debt. In practice, if there is both an equity exposure and an IRB credit exposure to the same counterparty, a default on the credit exposure would thus trigger a simultaneous default for regulatory purposes on the equity exposure. If a bank does not hold debt of the company in whose equity it has invested and does not have sufficient information on the position of that company to be able to use the applicable definition of default in practice but meets the other standards, a 1.5 scaling factor will be applied to the risk weights derived from the corporate risk weight function, given the PD set by the bank. If, however, the bank’s equity holding are material and it is permitted to use a PD/LGD approach for regulatory purposes, but the bank has not yet met the relevant standards, the simple risk weight method under the market-based approach apply.