7. Collateral
Banks should ensure proper collateral management and apply the following requirements throughout the credit process irrespective of the performance on the loan.
7.1 Governance
i. Banks should develop policies and procedures in order to ensure proper management of collateral obtained to mitigate the risk of loss associated with the potential default of the borrowers. Collateral policies and procedures should be approved by the Board of Directors or its delegated authority and should be reviewed at least every three years or more frequently if the bank deems is necessary based on the changes in the relevant regulatory requirements or business practices. Collateral policies and procedures should be fully aligned with the bank’s risk appetite statement (RAS).
ii. Consistent with SAMA’s requirements on valuation of real-estate collateral, banks should institute an appropriate governance process with respect to valuers and their performance standards. Banks should monitor and review the valuations performed by internal or external valuers on a regular basis, as well as develop and implement a robust internal quality assurance of such valuations.
iii. The internal audit function of banks should regularly review the consistency and quality of the collateral policies and procedures, the independence of the valuers selection process and the appropriateness of the valuations carried out by valuers.
7.2 Types of Collateral and Guarantees
Banks should clearly document in collateral policies and procedures the types of collateral they accept and the process in respect of the appropriate amount of each type of collateral relative to the loan amount. Banks should classify the collaterals they accept as follows:
i. Financial collateral - cash (money in bank accounts), securities (both debt and equity) and credit claims (sums owed to banks).
ii. Immovable collateral - immovable object, an item of property that cannot be moved without destroying or altering it - a property that is fixed to the earth, such as land or a house.
iii. Receivables - also referred to as accounts receivable, are debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
iv. Other physical collateral - physical collateral other than immovable property.
v. Treating lease exposures as collateral - exposure arising from leasing transactions as collateralized by the type of property leased.
vi. Other funded credit Protection - cash on deposit with, or cash assimilated instruments held by, a third party bank should come under this category.
vii. Guarantee- is a promise from a bank, corporate, any other entity or individual, that the liabilities of a borrower will be met in the event of failure to fulfil contractual obligations.
7.3 General Requirements for Collateral
Banks should ensure that the following requirements are incorporated with respect to the management of collaterals accepted by them:
i. Banks should properly document the collateral arrangements and have in place clear and robust procedures that ensure that any legal conditions required for declaring the default of a borrower and timely collection/ liquidation of collateral are observed.
ii. Banks should fulfil any contractual and statutory requirements in respect of, and take all steps necessary to ensure, the enforceability of the collateral arrangements under the law applicable to their interest in the collateral. In connection therewith, banks should conduct sufficient legal review confirming the enforceability of the collateral arrangements in all areas of operations, for example, foreign branches and subsidiaries. They should re-conduct such review as necessary to ensure continuing enforceability.
iii. The collateral policies and procedures should ensure mitigation of risks arising from the use of collateral, including risks of failed or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the bank's overall risk profile.
iv. The financing agreements should include detailed descriptions of the collateral as well as detailed specifications of the manner and frequency of revaluation.
v. Banks should calculate the market and the forced sale values (incorporating haircuts) of the collateral at a minimum frequency to enable it to form an objective view of borrower or workout viability; such valuations should incorporate the cost and time to realise, maintain and sell the collateral in the event of foreclosure.
vi. Where the collateral is held by a third party, banks should take reasonable steps to ensure that the third party segregates the collateral from its own assets.
vii. While conducting valuation and revaluation, banks should take into account any deterioration or obsolescence of the collateral.
viii. Banks should have the right to physically inspect the collateral. They should also have in place policies and procedures addressing their exercise of the right to physical inspection.
ix. When applicable, the collateral taken as protection should be adequately insured against the risk of damage the risk of damage.
7.4 Specific Requirements for Each Type of Collateral and Guarantees
A) Financial collateral
Under all approaches and methods, financial collateral should qualify as eligible collateral where all the following requirements are met:
i. The credit quality of the borrower and the value of the collateral should not have a material positive correlation. Where the value of the collateral is reduced significantly, this should not alone imply a significant deterioration of the credit quality of the borrower. Where the credit quality of the borrower becomes critical, this should not alone imply a significant reduction in the value of the collateral.
Securities issued by the borrower, or any related group entity, should not qualify as eligible collateral. Notwithstanding the aforementioned, a borrower's own issues of covered bonds qualify as eligible collateral, when they are posted as collateral for a repurchase transaction, provided that they comply with the condition set out in this paragraph.
ii. Banks should ensure that sufficient resources are devoted to the orderly operation of margin agreements with OTC derivatives and securities-financing counterparties, as measured by the timeliness and accuracy of their outgoing margin calls and response time to incoming margin calls.
B) Immovable property
i. Banks should clearly document the types of residential and commercial immovable property they accept in their lending policies.
ii. Immovable collateral should be classified in the following categories based on the underlying nature and behaviour:
a) Investment properties;
b) Owner-occupied properties;
c) Development properties;
d) Properties normally valued on the basis of trading potential.
C) Receivables
Receivables should qualify as eligible collateral, where all the following requirements are met:
i. Banks should have in place a sound process for determining the credit risk associated with the receivables, such a process should include analyses of a borrower's business and industry and the types of customers with whom that borrower does business. Where the bank relies on its borrowers to ascertain the credit risk of the customers, the bank should review the borrowers' credit practices to ascertain their soundness and credibility;
ii. The difference between the amount of the loan and the value of the receivables should reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual borrower, and potential concentration risk within the bank's total loans beyond that controlled by the bank's general methodology.
iii. Banks should maintain a continuous monitoring process appropriate to the receivables. They should also review, on a regular basis, compliance with loan covenants, environmental restrictions, and other legal requirements;
iv. Receivables pledged by a borrower should be diversified and not be unduly correlated with that borrower. Where there is a material positive correlation, banks should take into account the attendant risks in the setting of margins for the collateral pool as a whole;
v. Banks should not use receivables from subsidiaries and affiliates of a borrower, including employees, as eligible credit protection:
vi. Banks should have in place a documented process for collecting receivable payments in distressed situations. Banks should have in place the requisite facilities for collection even when they normally rely on their borrowers for collections.
D) Other physical collateral
Physical collateral other than immovable property should qualify as eligible collateral, when the conditions specified as general requirements for collateral are met.
E) Treating lease exposures as collateralized
Banks should treat exposures arising from leasing transactions as collateralized by the type of property leased, where all the following conditions are met:
i. The conditions set out for the type of asset/property leased to qualify as eligible collateral are met;
ii. The lessor has in place robust risk management with respect to the use to which the leased asset is put, its location, its age and the planned duration of its use, including appropriate monitoring of its value;
iii. Where this has not already been ascertained in calculating the Loss Given Default level, the difference between the value of the unamortized amount and the market value of the security is not so large as to overstate the credit risk mitigation attributed to the leased assets.
F) Other funded credit protection
Cash on deposit with, or cash assimilated instruments held by, a third-party institution should be eligible, where all the following conditions are met:
i. The borrower's claim against the third party institution is openly pledged or assigned to the lending bank and such pledge or assignment is legally effective and enforceable and is unconditional and irrevocable;
ii. The third party institution is notified of the pledge or assignment;
iii. As a result of the notification, the third party institution is able to make payments solely to the lending bank, or to other parties only with the lending bank's prior consent.
G) Guarantees
Credit protection deriving from a guarantee should qualify as eligible unfunded credit protection where all the following conditions are met:
i. The credit protection is direct and explicitly document the obligation assumed by the protection provider;
ii. The extent of the credit protection is clearly defined and incontrovertible;
iii. The credit protection contract does not contain any clause, the fulfillment of which is outside the direct control of the bank, that would:
a) allow the protection provider to cancel the protection unilaterally;
b) increase the effective cost of protection as a result of a deterioration in the credit quality of the protected loan;
c) prevent the protection provider from being obliged to pay out in a timely manner in the event that the original borrower fails to make any payments due, or when the leasing contract has expired for the purposes of recognizing the guaranteed residual value;
d) allow the maturity of the credit protection to be reduced by the protection provider.
iv. The credit protection contract is legally effective and enforceable, at the time of the conclusion of the credit agreement and thereafter i.e. over the life of the exposure;
v. The credit protection covers all types of payments the borrower is expected to make in respect of the claim. Where certain types of payment are excluded from the credit protection, the lending bank has to adjust, the value of credit protection to reflect the limited coverage;
vi. On the qualifying default of or non-payment by the borrower, the lending bank has the right to pursue, in a timely manner, the protection provider for any monies due under the claim in respect of which the protection is provided and the payment by the protection provider should not be subject to the lending bank first having to pursue the borrower. 7.5 Valuation Frequency
i. Banks should clearly document in collateral policies and procedures the frequency of collateral valuations. The policies and procedures should also provide for the following:
a) Banks monitor the value of each type of collateral on a defined frequent basis.
b) More frequent valuations where the market is subject to significant negative changes and/or where there are signs of a significant decline in the value of an individual collateral.
c) Defined criteria for determining that a significant decline in collateral value has taken place. These will include quantitative thresholds for each type of collateral established, based on the observed empirical data and qualitative bank experience, taking into consideration relevant factors such as market price trends or the opinion of independent valuers.
d) Revaluation of collateral for restructuring cases should be done only where necessary, and should be done in accordance with the requirements of these rules.
ii. Banks should have appropriate IT processes and systems in place to flag outdated valuations and to trigger valuation reports.
7.6 Specific Requirements for Valuers
Banks valuation process should be carried out by valuers who possess the necessary qualifications, ability and experience to execute a valuation and who are independent of the credit decision process.
Banks should ensure compliance with SAMA circular no. 371000061185 dated 28/05/1437AH on "Obligations of Real Estate Appraisal Clients Subject to SAMA Supervision" and the revision made to the said circular through circular no. 65768/99 dated 25/10/1439AH along with all relevant regulatory requirements in that regard.