A. Regulatory Capital Under Basel III
2. Definition of Regulatory Capital for Basel III
2.1 A Summary of Components of Capital
Total regulatory capital will consist of the sum of the following elements:
• Tier 1 Capital (going-concern capital)
a. Common Equity Tier 1Capital
b. Additional Tier 1Capital
• Tier 2 Capital
For each of the three categories above (Tier-1-a, Tier-1-b and Tier-2 capital) there are sets of criteria that instruments are required to meet before inclusion in the relevant category. (Refer to attachment # 2 to 4).
Limits and minima
All elements above are net of the associated regulatory adjustments and are subject to the following restrictions (see also Annex 1):
• Common Equity Tier 1 must be at least 4.5% of risk-weighted assets at all times.
• Tier 1 Capital must be at least 6.0% of risk-weighted assets at all times.
• Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 8.0% of risk weighted assets at all times.
2.2 Details on Components of Regulatory Capital
2.2.1 Common Equity Tier 1
Common Equity Tier 1 capital consists of the sum of the following elements:
• Common shares issued by the bank that meet the criteria for classification as common shares for regulatory purposes (or the equivalent for non-joint stock companies);
• Stock surplus (share premium) resulting from the issue of instruments included Common Equity Tier 1;
• Retained earnings;
• Accumulated other comprehensive income and other disclosed reserves;
(There is no adjustment applied to remove from Common Equity Tier 1 unrealized gains or losses recognized on the balance sheet. Unrealized losses are subject to the transitional arrangements set out in paragraph 94 (c) and (d) Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems, 2011.)
• Common shares issued by consolidated subsidiaries of the bank and held by third parties (i.e. minority interest) that meet the criteria for inclusion in Common Equity Tier 1 capital.
• Retained earnings and other comprehensive income include interim profit or loss.
• Dividends are removed from Common Equity Tier 1 in accordance with applicable accounting standards. The treatment of minority interest and the regulatory adjustments applied in the calculation of Common Equity Tier 1 are addressed in separate sections.
Common shares issued by the bank
For an instrument to be included in Common Equity Tier 1 capital it must meet all of the criteria that an outlined in Annex-2. The vast majority of internationally active banks are structured as joint stock companies. (Joint stock companies are defined as companies that have issued common shares, irrespective of whether these shares are held privately or publically. These will represent the vast majority of internally active banks)1 and for these banks the criteria must be met solely with common shares.
In the rare cases where banks need to issue non-voting common shares as part of Common Equity Tier 1, they must be identical to voting common shares of the issuing bank in all respects except the absence of voting rights.
• Common shares issued by consolidated subsidiaries are described in section 3 of this document.
Regulatory adjustments applied in the calculation of Common Equity Tier 1 are described in section 4 of this document.
• Common shares issued by consolidated subsidiaries are described in section 3 of this document.
2.2.2. Additional Tier 1 capital
• A minimum set of criteria for an instrument issued by the bank to meet or to exceed in order for its to be included in additional Tier-1 Capital and described in Annex # 3.
Additional Tier 1 capital consists of the sum of the following elements:
• Instruments issued by the bank that meet the criteria for inclusion in Additional Tier 1 capital (and are not included in Common Equity Tier 1); Refer to paragraph 87-89, A global regulatory framework for more resilient banks and banking systems – revised version (rev June 2011)
• Stock surplus (share premium) resulting from the issue of instruments included in Additional Tier 1 capital;
• Instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in Additional Tier 1 capital and are not included in Common Equity Tier 1. Refer to section 3 for the relevant criteria; and
• Regulatory adjustments applied in the calculation of Additional Tier 1 Capital are addressed in section 4 of this document.
• Tier-1 Capital instruments issued by consolidated subsidiaries are described in section 3 of this document.
2.2.3. Tier 2 Capital
The objective of Tier 2 is to provide loss absorption on a gone-concern basis. Based on this objective, the following out the minimum set of criteria for an instrument to meet or exceed in order for it to be included in Tier 2 capital. (Annex 4)
• For details on the qualifying criteria for Tier 2 capital, please refer to annex # 4.
Tier 2 capital consists of the sum of the following elements:
• Instruments issued by the bank that meet the criteria for inclusion in Tier 2 capital (and are not included in Tier 1 capital);
• Stock surplus (share premium) resulting from the issue of instruments included in Tier 2 capital;
• Instruments issued by consolidated subsidiaries of the bank and held by third parties that meet the criteria for inclusion in Tier 2 capital and are not included in Tier 1 capital are described in section 3.
• Certain loan loss provisions
• Regulatory adjustments applied in the calculation of Tier 2 Capital.
The treatment of regulatory adjustments applied in the calculation of Tier 2 Capital are addressed in section 4.
Stock surplus (share premium) resulting from the issue of instruments included in Tier 2 capital;
Stock surplus (i.e. share premium) that is not eligible for inclusion in Tier 1, will only be permitted to be included in Tier 2 capital if the shares giving rise to the stock surplus are permitted to be included in Tier 2 capital.
General provisions/general loan-loss reserves (for banks using the Standardized Approach for credit risk)
Provisions or loan-loss reserves held against future, presently unidentified losses are freely available to meet losses which subsequently materialize and therefore qualify for inclusion within Tier 2. Provisions ascribed to identified deterioration of particular assets or known liabilities, whether individual or grouped, should be excluded. Furthermore, general provisions/general loan-loss reserves eligible for inclusion in Tier 2 will be limited to a maximum of 1.25 percentage points of credit risk-weighted risk assets calculated under the Standardized approach.
Excess of total eligible provisions under the Internal Ratings-based Approach
Where the total expected loss amount is less than total eligible provisions, as explained in paragraphs 380 to 383 of the June 2006 Comprehensive version of Basel II, banks may recognize the difference in Tier 2 capital up to a maximum of 0.6% of credit risk weighted assets calculated under the IRB approach. SAMA may apply a lower limit than 0.6% which will be communicated to banks.
3. Minority Interest (i.e. Non-Controlling Interest) and Other Capital Issued Out of Consolidated Subsidiaries that is Held by Third Parties
Note: Minority Interests arise on the full consolidation of majority held subsidiaries.
3.1 Common Shares Issued by Consolidated Subsidiaries
Minority interest arising from the issue of common shares by a fully consolidated subsidiary of the bank may receive recognition in Common Equity Tier 1 only if (1) the instrument giving rise to the minority interest would, if issued by the bank, meet all of the criteria for classification as common shares for regulatory capital purposes; and (2) the subsidiary that issued the instrument is itself a bank (for the purposes of this paragraph, any institution that is subject to the same minimum prudential standards and level of supervision as a bank may be considered to be a bank.) & (Minority interest in a subsidiary that is a bank is strictly excluded from the parent bank’s common equity if the parent bank or affiliate has entered into any arrangements to fund directly or indirectly minority investment in the subsidiary whether through an SPV or through another vehicle or arrangement. The treatment outlined above, thus, is strictly available where all minority investments in the bank subsidiary solely represent genuine third party common equity contributions to the subsidiary).
The amount of minority interest meeting the criteria above that will be recognized in consolidated Common Equity Tier 1 will be calculated as follows:
• Total minority interest meeting the two criteria above minus the amount of the surplus Common Equity Tier 1 of the subsidiary attributable to the minority shareholders.
• Surplus Common Equity Tier 1 of the subsidiary is calculated as the Common Equity Tier 1 of the subsidiary minus the lower of: (1) the minimum Common Equity Tier 1 requirement of the subsidiary plus the capital conservation buffer (i.e. 7.0% of risk weighted assets) and (2) the portion of the consolidated minimum Common Equity Tier 1 requirement plus the capital conservation buffer (i.e. 7.0% of consolidated risk weighted assets) that relates to the subsidiary.
• The amount of the surplus Common Equity Tier 1 that is attributable to the minority shareholders is calculated by multiplying the surplus Common Equity Tier 1 by the percentage of Common Equity Tier 1 that is held by minority shareholders.
Refer to para 62 A global regulatory framework for more resilient bank.
3.2 Tier 1 Qualifying Capital Issued by Consolidated Subsidiaries
Tier 1 capital instruments issued by a fully consolidated subsidiary of the bank to third party investors including amounts under paragraph 62 of the BCBS document of June 2011 may receive recognition in Tier 1 capital only if the instruments would, if issued by the bank, meet all of the criteria for classification as Tier 1 capital. The amount of this capital that will be recognized in Tier 1 will be calculated as follows:
• Total Tier 1 of the subsidiary issued to third parties minus the amount of the surplus Tier 1 of the subsidiary attributable to the third party investors.
• Surplus Tier 1 of the subsidiary is calculated as the Tier 1 of the subsidiary minus the lower of: (1) the minimum Tier 1 requirement of the subsidiary plus the capital conservation buffer (ie 8.5% of risk weighted assets) and (2) the portion of the consolidated minimum Tier 1 requirement plus the capital conservation buffer (ie 8.5% of consolidated risk weighted assets) that relates to the subsidiary.
• The amount of the surplus Tier 1 that is attributable to the third party investors is calculated by multiplying the surplus Tier 1 by the percentage of Tier 1 that is held by third party investors.
The amount of this Tier 1 capital that will be recognized in Additional Tier 1 will exclude amounts recognized in Common Equity Tier 1 Capital under paragraph 62 of BCBS document of June 2011.
3.3 Tier 1 and Tier 2 Qualifying Capital Issued by Consolidated Subsidiaries
Total capital instruments (ie Tier 1 and Tier 2 capital instruments) issued by a fully consolidated subsidiary of the bank to third party investors (including amounts under paragraph 3.1 and 3.2) may receive recognition in Total Capital only if the instruments would, if issued by the bank, meet all of the criteria for classification as Tier 1 or Tier 2 capital. The amount of this capital that will be recognized in consolidated Total Capital will be calculated as follows:
• Total capital instruments of the subsidiary issued to third parties minus the amount of the surplus Total Capital of the subsidiary attributable to the third party investors.
• Surplus Total Capital of the subsidiary is calculated as the Total Capital of the subsidiary minus the lower of: (1) the minimum Total Capital requirement of the subsidiary plus the capital conservation buffer (i.e. 10.5% of risk weighted assets) and (2) the portion of the consolidated minimum Total Capital requirement plus the capital conservation buffer (i.e. 10.5% of consolidated risk weighted assets) that relates to the subsidiary.
• The amount of the surplus Total Capital that is attributable to the third party investors is calculated by multiplying the surplus Total Capital by the percentage of Total Capital that is held by third party investors.
The amount of this Total Capital that will be recognized in Tier 2 will exclude amounts recognized in Common Equity Tier 1 under paragraph 3.1 and amounts recognized in Additional Tier 1 under paragraph 3.2.
Paragraphs 64-65: A global regulatory framework for more resilient banks and banking systems – revised version (rev June 2011).
Where capital has been issued to third parties out of a special purpose vehicle (SPV), none of this capital can be included in Common Equity Tier 1. However, such capital can be included in consolidated Additional Tier 1 or Tier 2 and treated as if the bank itself had issued the capital directly to the third parties only if it meets all the relevant entry criteria and the only asset of the SPV is its investment in the capital of the bank in a form that meets or exceeds all the relevant entry criteria (as required by criterion 14 for Additional Tier 1 and criterion 9 for Tier 2). In cases where the capital has been issued to third parties through an SPV via a fully consolidated subsidiary of the bank, such capital may, subject to the requirements of this paragraph, be treated as if the subsidiary itself had issued it directly to the third parties and may be included in the bank’s consolidated Additional Tier 1 or Tier 2 in accordance with the treatment outlined in paragraphs 63 and 64 of the BCBS document of June 2011.
4. Regulatory Adjustments or "Filter"
4.1
This section sets out the regulatory adjustments to be applied to regulatory capital. In most cases these adjustments are applied in the calculation of Common Equity Tier 1.
4.1.1 Goodwill and Other Intangibles (Except Mortgage Servicing Rights)
Goodwill and all other intangibles must be deducted in the calculation of Common Equity Tier 1, including any goodwill included in the valuation of significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation. With the exception of mortgage servicing rights, the full amount is to be deducted net of any associated deferred tax liability which would be extinguished if the intangible assets become impaired or derecognized under the relevant accounting standards. The amount to be deducted in respect of mortgage servicing rights is set out in the threshold deductions section below.
Subject to prior supervisory approval, banks that report under local GAAP may use the IFRS definition of intangible assets to determine which assets are classified as intangible and are thus required to be deducted.
4.1.2 Deferred Tax Assets
Deferred tax assets (DTAs) that rely on future profitability of the bank to be realized are to be deducted in the calculation of Common Equity Tier 1. Deferred tax assets may be netted with associated deferred tax liabilities (DTLs) only if the DTAs and DTLs relate to taxes levied by the same taxation authority and offsetting is permitted by the relevant taxation authority. Where these DTAs relate to temporary differences (e.g. allowance for credit losses) the amount to be deducted is set out in the “threshold deductions” section below. All other such assets, e.g. those relating to operating losses, such as the carry forward of unused tax losses, or unused tax credits, are to be deducted in full net of deferred tax liabilities as described above. The DTLs permitted to be netted against DTAs must exclude amounts that have been netted against the deduction of goodwill, intangibles and defined benefit pension assets, and must be allocated on a pro rata basis between DTAs subject to the threshold deduction treatment and DTAs that are to be deducted in full.
An over installment of tax or, in some jurisdictions, current year tax losses carried back to prior years may give rise to a claim or receivable from the government or local tax authority. Such amounts are typically classified as current tax assets for accounting purposes. The recovery of such a claim or receivable would not rely on the future profitability of the bank and would be assigned the relevant sovereign risk weighting.
4.1.3 Cash Flow Hedge Reserves
The amount of the cash flow hedge reserves that relates to the hedging of items that are not fair valued on the balance sheet (including projected cash flows) should be derecognized in the calculation of Common Equity Tier 1. This means that positive amounts should be deducted and negative amounts should be added back.
This treatment specifically identifies the element of the cash flow hedge reserve that is to be derecognized for prudential purposes. It removes the element that gives rise to artificial volatility in common equity, as in this case the reserve only reflects one half of the picture (the fair value of the derivative, but not the changes in fair value of the hedged future cash flow).
4.1.4 Shortfall of the Stock of Provisions to Expected Losses
The deduction from capital in respect of a shortfall of the stock of provisions to expected losses under the IRB approach should be made in the calculation of Common Equity Tier 1. The full amount is to be deducted and should not be reduced by any tax effects that could be expected to occur if provisions were to rise to the level of expected losses.
Gain on sale related to securitization transactions
Derecognize in the calculation of Common Equity Tier 1 any increase in equity capital resulting from a securitization transaction, such as that associated with expected future margin income (FMI) resulting in a gain-on- sale.
Cumulative gains and losses due to changes in own credit risk on fair valued financial liabilities
Derecognize in the calculation of Common Equity Tier 1, all unrealized gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank’s own credit risk.
In addition, with regard to derivative liabilities, derecognize all accounting valuation adjustments arising from the bank's own credit risk. The offsetting between valuation adjustments arising from the bank's own credit risk and those arising from its counterparties' credit risk is not allowed.
(BIS has issued its final guidelines (July 2012) titled “Regulatory treatment of valuation adjustments to derivative liabilities - final rule issued by the Basel Committee”. Banks are advised to refer to the aforementioned, these would be regarded as binding by SAMA with respect to capital computation / capital adequacy under Basel III guidelines.
4.1.5 Defined Benefit Pension Fund Assets and Liabilities
Defined benefit pension fund liabilities, as included on the balance sheet, must be fully recognized in the calculation of Common Equity Tier 1 (ie Common Equity Tier 1 cannot be increased through derecognizing these liabilities). For each defined benefit pension fund that is an asset on the balance sheet, the asset should be deducted in the calculation of Common Equity Tier 1 net of any associated deferred tax liability which would be extinguished if the asset should become impaired or derecognized under the relevant accounting standards. Assets in the fund to which the bank has unrestricted and unfettered access can, with supervisory approval, offset the deduction. Such offsetting assets should be given the risk weight they would receive if they were owned directly by the bank.
This treatment addresses the concern that assets arising from pension funds may not be capable of being withdrawn and used for the protection of depositors and other creditors of a bank. The concern is that their only value stems from a reduction in future payments into the fund. The treatment allows for banks to reduce the deduction of the asset if they can address these concerns and show that the assets can be easily and promptly withdrawn from the fund.
4.1.6 Investments in Own Shares (Treasury Stock)
All of a bank’s investments in its own common shares, whether held directly or indirectly, will be deducted in the calculation of Common Equity Tier 1 (unless already derecognized under the relevant accounting standards). In addition, any own stock which the bank could be contractually obliged to purchase should be deducted in the calculation of Common Equity Tier 1. The treatment described will apply irrespective of the location of the exposure in the banking book or the trading book. In addition:
• Gross long positions may be deducted net of short positions in the same underlying exposure only if the short positions involve no counterparty risk.
• Banks should look through holdings of index securities to deduct exposures to own shares. However, gross long positions in own shares resulting from holdings of index securities may be netted against short position in own shares resulting from short positions in the same underlying index. In such cases the short positions may involve counterparty risk (which will be subject to the relevant counterparty credit risk charge).
This deduction is necessary to avoid the double counting of a bank’s own capital. Certain accounting regimes do not permit the recognition of treasury stock and so this deduction is only relevant where recognition on the balance sheet is permitted. The treatment seeks to remove the double counting that arises from direct holdings, indirect holdings via index funds and potential future holdings as a result of contractual obligations to purchase own shares.
Following the same approach outlined above, banks must deduct investments in their own Additional Tier 1 in the calculation of their Additional Tier 1 capital and must deduct investments in their own Tier 2 in the calculation of their Tier 2 capital.
4.1.7 Reciprocal Cross Holdings in the Capital of Banking, Financial and Insurance Entities
Reciprocal cross holdings of capital that are designed to artificially inflate the capital position of banks will be deducted in full. Banks must apply a “corresponding deduction approach” to such investments in the capital of other banks, other financial institutions and insurance entities. This means the deduction should be applied to the same component of capital for which the capital would qualify if it was issued by the bank itself.
4.2
Investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation and where the bank does not own more than 10% of the issued common share capital of the entity.
The regulatory adjustment described in this section applies to investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation and where the bank does not own more than 10% of the issued common share capital of the entity. In addition:
• Investments include direct, indirect1 and synthetic holdings of capital instruments. For example, banks should look through holdings of index securities to determine their underlying holdings of capital.2
• Holdings in both the banking book and trading book are to be included. Capital includes common stock and all other types of cash and synthetic capital instruments (e.g. subordinated debt). It is the net long position that is to be included (i.e. the gross long position net of short positions in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year).
• Underwriting positions held for five working days or less can be excluded. Underwriting positions held for longer than five working days must be included.
• If the capital instrument of the entity in which the bank has invested does not meet the criteria for Common Equity Tier 1, Additional Tier 1, or Tier 2 capital of the bank, the capital is to be considered common shares for the purposes of this regulatory adjustment.3
Amounts below the threshold, which are not deducted, will continue to be risk weighted. Thus, instruments in the trading book will be treated as per the market risk rules and instruments in the banking book should be treated as per the internal ratings-based approach or the standardized approach (as applicable). For the application of risk weighting the amount of the holdings must be allocated on a pro rata basis between those below and those above the threshold.
1 Indirect holdings are exposures or parts of exposures that, if a direct holding loses its value, will result in a loss to the bank substantially equivalent to the loss in value of the direct holding.
2 If banks find it operationally burdensome to look through and monitor their exact exposure to the capital of other financial institutions as a result of their holdings of index securities, SAMA may permit banks, subject to prior supervisory approval, to use a conservative estimate.
3 If the investment is issued out of a regulated financial entity and not included in regulatory capital in the relevant sector of the financial entity, it is not required to be deducted.4.2.1
If the total of all holdings listed above in aggregate exceed 10% of the bank’s common equity (after applying all other regulatory adjustments in full listed prior to this one) then the amount above 10% is required to be deducted, applying a corresponding deduction approach. This means the deduction should be applied to the same component of capital for which the capital would qualify if it was issued by the bank itself. Accordingly, the amount to be deducted from common equity should be calculated as the total of all holdings which in aggregate exceed 10% of the bank’s common equity (as per above) multiplied by the common equity holdings as a percentage of the total capital holdings. This would result in a common equity deduction which corresponds to the proportion of total capital holdings held in common equity. Similarly, the amount to be deducted from Additional Tier 1 capital should be calculated as the total of all holdings which in aggregate exceed 10% of the bank’s common equity (as per above) multiplied by the Additional Tier 1 capital holdings as a percentage of the total capital holdings. The amount to be deducted from Tier 2 capital should be calculated as the total of all holdings which in aggregate exceed 10% of the bank’s common equity (as per above) multiplied by the Tier 2 capital holdings as a percentage of the total capital holdings.
If, under the corresponding deduction approach, a bank is required to make a deduction from a particular tier of capital and it does not have enough of that tier of capital to satisfy that deduction, the shortfall will be deducted from the next higher tier of capital (eg if a bank does not have enough Additional Tier 1 capital to satisfy the deduction, the shortfall will be deducted from Common Equity Tier 1).
4.3 Significant investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation 1
The regulatory adjustment described in this section applies to investments in the capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation where the bank owns more than 10% of the issued common share capital of the issuing entity or where the entity is an affiliate2 of the bank. In addition:
• Investments include direct, indirect and synthetic holdings of capital instruments. For example, banks should look through holdings of index securities to determine their underlying holdings of capital.3
• Holdings in both the banking book and trading book are to be included. Capital includes common stock and all other types of cash and synthetic capital instruments (e.g. subordinated debt). It is the net long position that is to be included (i.e. the gross long position net of short positions in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year).
• Underwriting positions held for five working days or less can be excluded. Underwriting positions held for longer than five working days must be included.
• If the capital instrument of the entity in which the bank has invested does not meet the criteria for Common Equity Tier 1, Additional Tier 1, or Tier 2 capital of the bank, the capital is to be considered common shares for the purposes of this regulatory adjustment.4
• National discretion applies to allow banks, with prior supervisory approval, to exclude temporarily certain investments where these have been made in the context of resolving or providing financial assistance to reorganize a distressed institution. (If necessary and relevant, please refer to SAMA for further guidance.)
All investments included above that are not common shares must be fully deducted following a corresponding deduction approach. This means the deduction should be applied to the same tier of capital for which the capital would qualify if it was issued by the bank itself. If the bank is required to make a deduction from a particular tier of capital and it does not have enough of that tier of capital to satisfy that deduction, the shortfall will be deducted from the next higher tier of capital (e.g. if a bank does not have enough Additional Tier 1 capital to satisfy the deduction, the shortfall will be deducted from Common Equity Tier 1).
Investments included above that are common shares will be subject to the threshold treatment described in the next section.
1 Investments in entities that are outside of the scope of regulatory consolidation refers to investments in entities that have not been consolidated at all or have not been consolidated in such a way as to result in their assets being included in the calculation of consolidated risk-weighted assets of the group.
2 An affiliate of a bank is defined as a company that controls, or is controlled by, or is under common control with, the bank. Control of a company is defined as (1) ownership, control, or holding with power to vote 20% or more of a class of voting securities of the company; or (2) consolidation of the company for financial reporting purposes.
3 If banks find it operationally burdensome to look through and monitor their exact exposure to the capital of other financial institutions as a result of their holdings of index securities, SAMA may permit banks to use a conservative estimate.
4 If the investment is issued out of a regulated financial entity and not included in regulatory capital in the relevant sector of the financial entity, it is not required to be deducted.4.4 Threshold Deductions
Instead of a full deduction, the following items may each receive limited recognition when calculating Common Equity Tier 1, with recognition capped at 10% of the bank’s common equity (after the application of all regulatory adjustments set out in paragraphs 4.1.1 to 4.3):
• Significant investments in the common shares of unconsolidated financial institutions (banks, insurance and other financial entities) as referred to in paragraph 4.3 of this document; (Refer to paragraph 87,89, A global regulatory framework for more resilient bank and banking systems – revised version (rev June 2011)
• Mortgage servicing rights (MSRs); and
• DTAs that arise from temporary differences.
On 1 January 2013, a bank must deduct the amount by which the aggregate of the three items above exceeds 15% of its common equity component of Tier 1 (calculated prior to the deduction of these items but after application of all other regulatory adjustments applied in the calculation of Common Equity Tier 1). The items included in the 15% aggregate limit are subject to full disclosure. As of 1 January 2018, the calculation of the 15% limit will be subject to the following treatment: the amount of the three items that remains recognized after the application of all regulatory adjustments must not exceed 15% of the Common Equity Tier 1 capital, calculated after all regulatory adjustments. See Annex 2 for an example.
The amount of the three items that are not deducted in the calculation of Common Equity Tier 1 will be risk weighted at 250%. (Refer to Prudential Return)
4.10 Former Deductions from Capital
90. The following items, which under Basel II were deducted 50% from Tier 1 and 50% from Tier 2 (or had the option of being deducted or risk weighted), will receive a 1250% risk weight: (Refer to Prudential Return)
• Certain Securitization and Resecuritization exposures;
• Certain equity exposures under the PD/LGD approach;
• Non-payment/delivery on non-DvP and non-PvP transactions; and
• Significant investments in commercial entities.
5. Transitional Arrangements
The transitional arrangements for implementing the new standards will help to ensure that there is minimal disruption in banking sector, and that it can meet the higher capital standards through reasonable earnings retention and capital raising, while still supporting lending to the economy. The transitional arrangements include:
5.1 Minimum Capital Adequacy Ratio – Please Also Refer to Annex-1
National implementation by member countries will begin on 1 January 2013. Member countries must translate the rules into national laws and regulations before this date. As of 1 January 2013, banks will be required to meet the following new minimum requirements in relation to risk-weighted assets (RWAs):
– 3.5% Common Equity Tier 1/RWAs;
– 4.5% Tier 1 capital/RWAs, and
– 8.0% total capital/RWAs.
5.2 Phasing in of the Minimum Common Equity Tier 1 and Tier 1 Requirements
The minimum Common Equity Tier 1 and Tier 1 requirements will be phased in between 1 January 2013 and 1 January 2015. On 1 January 2013, the minimum Common Equity Tier 1 requirement will rise from the current 2% level to 3.5%. The Tier 1 capital requirement will rise from 4% to 4.5%. On 1 January 2014, banks will have to meet a 4% minimum Common Equity Tier 1 requirement and a Tier 1 requirement of 5.5%. On 1 January 2015, banks will have to meet the 4.5% Common Equity Tier 1 and the 6% Tier 1 requirements. The total capital requirement remains at the existing level of 8.0% and so does not need to be phased in. The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital.
5.3 15% Limit for Significant Investment
The regulatory adjustments (ie deductions and prudential filters), including amounts above the aggregate 15% limit for significant investments in financial institutions, mortgage servicing rights, and deferred tax assets from temporary differences, would be fully deducted from Common Equity Tier 1 by 1 January 2018.
5.4 Phasing in Regulatory Adjustment
In particular, the regulatory adjustments will begin at 20% of the required adjustments to Common Equity Tier 1 on 1 January 2014, 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017, and reach 100% on 1 January 2018. During this transition period, the remainder not deducted from Common Equity Tier 1 will continue to be subject to existing national treatments (Follow up). The same transition approach will apply to deductions from Additional Tier 1 and Tier 2 capital. Specifically, the regulatory adjustments to Additional Tier 1 and Tier 2 capital will begin at 20% of the required deductions on 1 January 2014, 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017, and reach 100% on 1 January 2018. During this transition period, the remainder not deducted from capital will continue to be subject to existing national treatments. (Follow up)
5.5 The Treatment of Capital Issued Out of Subsidiaries and Held by Third Parties
The treatment of capital issued out of subsidiaries and held by third parties (eg minority interest) will also be phased in. Where such capital is eligible for inclusion in one of the three components of capital according to paragraphs 63 to 65 of the BCBS document of June 2011, it can be included from 1 January 2013. Where such capital is not eligible for inclusion in one of the three components of capital but is included under the existing national treatment, 20% of this amount should be excluded from the relevant component of capital on 1 January 2014, 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017, and reach 100% on 1 January 2018.
5.6 Grand Fathering
Existing public sector capital injections will be grandfathered until 1 January 2018.
5.7 Capital Instruments that No Longer Qualify as Non-Common Equity Tier 1 Capital
Capital instruments that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital will be phased out beginning 1 January 2013. Fixing the base at the nominal amount of such instruments outstanding on 1 January 2013, their recognition will be capped at 90% from 1 January 2013, with the cap reducing by 10 percentage points in each subsequent year. This cap will be applied to Additional Tier 1 and Tier 2 separately and refers to the total amount of instruments outstanding that no longer meet the relevant entry criteria. To the extent an instrument is redeemed, or its recognition in capital is amortized, after 1 January 2013, the nominal amount serving as the base is not reduced. In addition, instruments with an incentive to be redeemed will be treated as follows:
– For an instrument that has a call and a step-up prior to 1 January 2013 (or another incentive to be redeemed), if the instrument is not called at its effective maturity date and on a forward-looking basis will meet the new criteria for inclusion in Tier 1 or Tier 2, it will continue to be recognized in that tier of capital.
– For an instrument that has a call and a step-up on or after 1 January 2013 (or another incentive to be redeemed), if the instrument is not called at its effective maturity date and on a forward looking basis will meet the new criteria for inclusion in Tier 1 or Tier 2, it will continue to be recognized in that tier of capital. Prior to the effective maturity date, the instrument would be considered an “instrument that no longer qualifies as Additional Tier 1 or Tier 2” and will therefore be phased out from 1 January 2013.
– For an instrument that has a call and a step-up between 12 September 2010 and 1 January 2013 (or another incentive to be redeemed), if the instrument is not called at its effective maturity date and on a forward looking basis does not meet the new criteria for inclusion in Tier 1 or Tier 2, it will be fully derecognized in that tier of regulatory capital from 1 January 2013.
– For an instrument that has a call and a step-up on or after 1 January 2013 (or another incentive to be redeemed), if the instrument is not called at its effective maturity date and on a forward looking basis does not meet the new criteria for inclusion in Tier 1 or Tier 2, it will be derecognized in that tier of regulatory capital from the effective maturity date. Prior to the effective maturity date, the instrument would be considered an “instrument that no longer qualifies as Additional Tier 1 or Tier 2” and will therefore be phased out from 1 January 2013.
– For an instrument that had a call and a step-up on or prior to 12 September 2010 (or another incentive to be redeemed), if the instrument was not called at its effective maturity date and on a forward looking basis does not meet the new criteria for inclusion in Tier 1 or Tier 2, it will be considered an “instrument that no longer qualifies as Additional Tier 1 or Tier 2” and will therefore be phased out from 1 January 2013.
Capital instruments that do not meet the criteria for inclusion in Common Equity Tier 1 will be excluded from Common Equity Tier 1 as of 1 January 2013. However, instruments meeting the following three conditions will be phased out over the same horizon described in paragraph 94(g): (1) they are issued by a non-joint stock company1; (2) they are treated as equity under the prevailing accounting standards; and (3) they receive unlimited recognition as part of Tier 1 capital under current national banking law.
Only those instruments issued before 12 September 2010 qualify for the above transition arrangements.
NOTE: Banks should also refer to SAMA Circular entitled "Elements of the Reforms to Raise the Quality of Regulatory Capital – Loss Absorbency at the Point of Non- Viability issued through SAMA Circular # BCS 5611 dated 13 February 2011.
1 Non-joint stock companies were not addressed in the Basel Committee’s 1998 agreement on instruments eligible for inclusion in Tier 1 capital as they do not issue voting common shares.