ANNEXURE 2: Document Enhanced: SAMA Detailed Guidance Document Relating to Pillar 1, June 2006

No: 351000123076

Date(g): 21/7/2014 | Date(h): 24/9/1435

Effective from Oct 01 2014 - Sep 30 2014
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Section 2.1 “Owned or Controlled Financial Entities”, Page 8 of the SAMA detailed guidance document relating to Pillar 1, June 2006

Original Paragraph to be deleted:

SAMA Requires that owned or controlled entities and securities entities should be fully consolidated for Basel II purposes

The revised paragraph would be as follows:

SAMA Requires that owned or controlled entities and securities entities should be fully consolidated for Basel II purposes to ensure that it captures the risk of the banking group Banking groups are groups that engage predominantly in banking activities and, in some countries, a banking group may be registered as a bank.

Banks are also required to ensure minimum capital adequacy on a consolidated as well as standalone basis by ensuring that the Parent banks also meet the SAMA mandated capital adequacy regulation under Pillar 1 of the Basel guidelines. Going forward all banks would be required to make two sets of prudential returns for Pillar 1 Capital Computations, the first one on a consolidated basis and the other on a standalone basis.

(Refer to Paragraph 21 of International Convergence of Capital Measurement and Capital Standards – June 2006)

“Scope of Application and other issues”, Page 12 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraph to be deleted

Reference to paragraph 24, 26 & 27 (SAMA Document) - Choice of rule between consolidation and deduction. All relevant financial activities will be consolidated, but, if not consolidated, deducted.

The revised paragraph would be as follows:

Reference to paragraph 24, 26 & 27 (SAMA Document) - Choice of rule between consolidation and deduction. All relevant financial activities will be consolidated, but, if not consolidated, deducted.

However, where subsidiary holdings are acquired through debt previously contracted and held on a temporary basis, are subject to different regulation, SAMA would require that the same are deducted from the Tier 1 capital base and Tier 2 Capital capital base in equal proportion i.e. 50% and 50%

SAMA will ensure that the entity that is not consolidated and for which the capital Investment is deducted meets minimum regulatory capital requirements of the concerned regulatory authority.

SAMA will monitor actions taken by the subsidiary to correct any capital shortfall and, if it is not corrected in a timely manner, the shortfall will also be deducted from the parent bank ‘s capital

(Refer to Paragraph 26 and 27 of International Convergence of Capital Measurement and Capital Standards – June 2006)

Section 2.2.1 Subsidiaries and Significant Minority Interests in Insurance Entities, Page 8 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraph to be deleted

[30 to 34] SAMA requires that all subsidiaries and significant minority interest in insurance entities at 10% or more are to be excluded from banks capital at 50% from Tier-I, and 50% from Tier-II capital.

The revised paragraph would be as follows:

[30 to 34] ((SAMA Document) SAMA requires that all subsidiaries and significant minority interest in insurance entities at 10% or more are to be excluded from banks capital at 50% from Tier-I, and 50% from Tier-II capital.

In addition, SAMA would not permit the recognition of surplus capital of an insurance subsidiary for the capital adequacy of the group –

(Refer to Paragraph 33 of International Convergence of Capital Measurement and Capital Standards – June 2006)

2.2.1-A Subsidiaries and Significant Minority Interests in Insurance Entities, Page 8 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

The new paragraph (would be inserted in addition to the other amendment identified above for Section 2.2.1) which would read as follows:

SAMA will ensure that majority-owned or controlled insurance subsidiaries, which are not consolidated and for which capital investments are deducted, are themselves adequately capitalized to reduce the Possibility of future potential losses to the bank. SAMA, through the parent banks will monitor actions taken by the subsidiary to correct any capital shortfall and, if it is not corrected in a timely manner, the shortfall will also be deducted from the parent bank ‘s capital.

(Refer to Paragraph 34 of International Convergence of Capital Measurement and Capital Standards – June 2006)

Section 2.3. “Significant investment in commercial entities”, Page 8 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraph to be deleted:

[35] (SAMA Document) "The new Basel framework provides that significant minority and majority investments in commercial entities, which exceed certain materiality levels, are to be deducted from Banks capital".

SAMA requires that the threshold and majority investments in commercial entities is 10% of shareholders 'equity and that the deduction would be 50 percent from Tier 1 capital and 50 percent from Tier 2 capital.

Investments held below the 10% threshold will be risk weighted at 100% under the Standardized Approach, and as per section 7.2.1 for the IRB Approaches.

The revised paragraph would be as follows:

[35] "The new Basel framework provides that significant minority and majority investments in commercial entities, which exceed certain materiality levels, are to be deducted from Banks capital".

Materiality levels of 10% of the bank ‘s capital for individual significant investments in commercial entities and 60% of the bank ‘s capital for the aggregate of such investments,. The amount exceeding this threshold would be risk weighted at 1250%.

Investments held below the 10% threshold will be risk weighted at 100% under the Standardized Approach, and as per section 7.2.1 for the IRB Approaches.

(Refer Paragraph 35 of International Convergence of Capital Measurement and Capital Standards – June 2006 & Para 90 of Basel III: A global regulatory framework for more resilient banks and banking systems)

The following guidelines will be read as part of Section 4.1.11 [82 to 89] Off balance sheet items: Page 20 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

The credit equivalent amount of OTC derivatives and SFTs that expose a bank to counterparty credit risk is to be calculated under the rules set forth in Annex 4 of International Convergence of Capital Measurement and Capital Standards, 2006.

(Refer to Paragraph 87 of International Convergence of Capital Measurement and Capital Standards – June 2006)

The following guidelines will be read as part of Section 4.1.11 [82 to 89] Off balance sheet items: Page 20 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

With regard to unsettled securities, commodities, and foreign exchange SAMA requires that bank ‘s prepares its Prudential return submission based on trade date rather than settlement date as per the accounting convention Banks are encouraged to develop, implement and improve systems for tracking and monitoring the credit risk exposure arising from unsettled transactions as appropriate for producing management information that facilitates action on a timely basis. Furthermore, when such transactions are not processed through a delivery-versus-payment (DvP) or payment-versus-payment (PvP) mechanism, banks must calculate a capital charge as set forth in Annex 3 of International Convergence of Capital Measurement and Capital Standards – June 2006

(Refer to Paragraph 89 of International Convergence of Capital Measurement and Capital Standards – June 2006)

The following would be a new subsection 6.4 titled “legal and operational certainty” on page 147, of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

All documentation used in collateralized transactions and for documenting, guarantees and credit derivatives must be binding on all parties and legally enforceable in all relevant jurisdictions. Banks must have conducted sufficient legal review to verify this and have a well-founded legal basis to reach this conclusion, and undertake such further review as necessary to ensure continuing enforceability. (Refer para 118, , International Convergence of Capital Measurement and Capital Standards – June 2006)

In addition to the general requirements for legal certainty set out in paragraphs 117 and 118 of, International Convergence of Capital Measurement and Capital Standards – June 2006, the legal mechanism by which collateral is pledged or transferred must ensure that the bank has the right to liquidate or take legal possession of it, in a timely manner, in the event of the default, insolvency or bankruptcy (or one or more otherwise-defined credit events set out in the transaction documentation) of the counterparty (and, where applicable, of the custodian holding the collateral). Furthermore banks must take all steps necessary to fulfil these requirements under the law applicable to the bank ‘s interest in the collateral for obtaining and maintaining an enforceable security interest, e.g. by registering it with a registrar, or for exercising a right to net or set off in relation to title transfer collateral. (Refer para 123, International Convergence of Capital Measurement and Capital Standards – June 2006)

In order for collateral to provide protection, the credit quality of the counterparty and the value of the collateral must not have a material positive correlation. For example, securities issued by the counterparty ─ or by any related group entity ─ would provide little protection and so would be ineligible.. (Refer para 124,, International Convergence of Capital Measurement and Capital Standards – June 2006)

Banks must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly.. (Refer para 125, , International Convergence of Capital Measurement and Capital Standards – June 2006)

Where the collateral is held by a custodian, banks must take reasonable steps to ensure that the custodian segregates the collateral from its own assets.

(Refer para 126, , International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of the comprehensive scope section (Section 6.1 (ii) laid out on page 145 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

The comprehensive approach for the treatment of collateral (Also refer to paragraphs 130 to 138 and 145 to 181 - International Convergence of Capital Measurement and Capital Standards – June 2006) will also be applied to calculate the counterparty risk charges for OTC Derivatives and repo-style transactions booked in the trading book. However, SAMA‘s overriding requirement that netting would not be allowed for capital adequacy purposes.

(Refer para 112, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part Section 6 of Credit Risk Mitigation, Collateral Management laid out on page 145 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

No transaction in which CRM techniques are used should receive a higher capital requirement than an otherwise identical transaction where such techniques are not used.

(Refer para 113, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part Section 6 of Credit Risk Mitigation, Collateral Management laid out on page 145 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

The effects of CRM will not be double counted. Therefore, no additional supervisory recognition of CRM for regulatory capital purposes will be granted on claims for which an issue-specific rating is used that already reflects that CRM. As stated in paragraph 100, International Convergence of Capital Measurement and Capital Standards – June 2006 of the section on the standardized approach, principal-only ratings will also not be allowed within the framework of CRM.

(Refer para 114, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part Section 6 of Credit Risk Mitigation, Collateral Management laid out on page 145 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

While the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks). Residual risks include legal, operational, liquidity and market risks. Therefore, it is imperative that banks employ robust procedures and processes to control these risks, including strategy; consideration of the underlying credit; valuation; policies and procedures; systems; control of roll-off risks; and management of concentration risk arising from the bank ‘s use of CRM techniques and its interaction with the bank ‘s overall credit risk profile. Where these risks are not adequately controlled, SAMA may impose additional capital charges or take other supervisory actions as outlined in Pillar 2.

(Refer para 115, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part Section 6 of Credit Risk Mitigation Collateral Management laid out on page 145 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

A collateralized transaction is one in which:

■

Banks have a credit exposure or potential credit exposure; and

■

That credit exposure or potential credit exposure is hedged in whole or in part by collateral posted by a counterparty or by a third party on behalf of the counterparty.

Here "counterparty" is used to denote a party to whom a bank has an on- or off-balance sheet credit exposure or a potential credit exposure. That exposure may, for example, take the form of a loan of cash or securities (where the counterparty would traditionally be called the borrower), of securities posted as collateral, of a commitment or of exposure under an OTC derivatives contract.

(Refer para 119, International Convergence of Capital Measurement and Capital Standards – June 2006)

As a new subsection 6.4.1, titled “ Repo-style transaction” on page 147, of the SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Where a bank, acting as an agent, arranges a repo-style transaction (i. e. repurchase/reverse repurchase and securities lending/borrowing transactions) between a customer and a third party and provides a guarantee to the customer that the third party will perform on its obligations, then the risk to the bank is the same as if the bank had Entered into the transaction as a principal. In such circumstances, a bank will be required to calculate capital requirements as if it were itself the principal.

(Refer para 128, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 147, Section 6.2, On balance sheet netting, SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraph was as follows:

Where banks have legally enforceable netting arrangements for loans and deposits they may calculate capital requirements on the basis of net credit exposures subject to the conditions in Basel II.

The revised paragraph would be as follows:

SAMA does not recognize netting for capital adequacy purposes

As part of subsection 6.3 titled “guarantees and credit derivatives” on page 147, of the SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

In addition to the legal certainty requirements in International Convergence of Capital Measurement and Capital Standards – June 2006, paragraphs 117 and 118, in order for a guarantee to be recognized, the following conditions must be satisfied:

(a)

On the qualifying default/non-payment of the counterparty, the bank may in a timely manner pursue the guarantor for any monies outstanding under the documentation governing the transaction. The guarantor may make one lump sum payment of all monies under such documentation to the bank, or the guarantor may assume the future payment obligations of the counterparty covered by the guarantee. The bank must have the right to receive any such payments from the guarantor without first having to take legal actions in order to pursue the counterparty for payment.

(b)

The guarantee is an explicitly documented obligation assumed by the guarantor.

(c)

Except as noted in the following sentence, the guarantee covers all types of payments the underlying obligor is expected to make under the documentation governing the transaction, for example notional amount, margin payments etc. where a guarantee covers payment of principal only, interests and other uncovered payments should be treated as an unsecured amount in accordance with BIS guidelines – in International Convergence of Capital Measurement and Capital Standards – June 2006, paragraph 198.

(Refer para 190, International Convergence of Capital Measurement and Capital Standards – June 2006)

As a new subsection Chapter 6.3.1 “additional operational requirements for credit derivatives”, SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

In order for a credit derivative contract to be recognized, the following conditions must be satisfied:

(a)

The credit events specified by the contracting parties must at a minimum cover:

■

failure to pay the amounts due under terms of the underlying obligation that are in effect at the time of such failure (with a grace period that is closely in line with the grace period in the underlying obligation);

■

bankruptcy, insolvency or inability of the obligor to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and analogous events; and

■

restructuring of the underlying obligation involving forgiveness or postponement of principal, interest or fees that results in a credit loss event (i.e. charge-off, specific provision or other similar debit to the profit and loss account). When restructuring is not specified as a credit event, refer to paragraph 192, International Convergence of Capital Measurement and Capital Standards – June 2006

(b)

If the credit derivative covers obligations that do not include the underlying obligation, section (g) below governs whether the asset mismatch is permissible.

(c)

The credit derivative shall not terminate prior to expiration of any grace period required for a default on the underlying obligation to occur as a result of a failure to pay, subject to the provisions of paragraph 203, International Convergence of Capital Measurement and Capital Standards – June 2006

(d)

Credit derivatives allowing for cash settlement are recognized for capital purposes insofar as a robust valuation process is in place in order to estimate loss reliably. There must be a clearly specified period for obtaining post-credit event valuations of the underlying obligation. If the reference obligation specified in the credit derivative for purposes of cash settlement is different than the underlying obligation, section (g) below governs whether the asset mismatch is permissible.

(e)

If the protection purchaser ‘s right/ability to transfer the underlying obligation to the protection provider is required for settlement, the terms of the underlying obligation must provide that any required consent to such transfer may not be unreasonably withheld.

(f)

The identity of the parties responsible for determining whether a credit event has occurred must be clearly defined. This determination must not be the sole responsibility of the protection seller. The protection buyer must have the right/ability to inform the protection provider of the occurrence of a credit event.

(g)

A mismatch between the underlying obligation and the reference obligation under the credit derivative (i.e. the obligation used for purposes of determining cash settlement value or the deliverable obligation) is permissible if (1) the reference obligation ranks pari passu with or is junior to the underlying obligation, and (2) the underlying obligation and reference obligation share the same obligor (i. e. the same legal entity) and legally enforceable cross-default or cross-acceleration clauses are in place.

(h)

A mismatch between the underlying obligation and the obligation used for purposes of determining whether a credit event has occurred is permissible if (1) the latter obligation ranks pari passu with or is junior to the underlying obligation, and (2) the underlying obligation and reference obligation share the same obligor (i.e. the same legal entity) and legally enforceable cross-default or cross acceleration clauses are in place.

When the restructuring of the underlying obligation is not covered by the credit derivative, but the other requirements in paragraph 191 are met, partial recognition of the credit derivative will be allowed. If the amount of the credit derivative is less than or equal to the amount of the underlying obligation, 60% of the amount of the hedge can be recognized as covered. If the amount of the credit derivative is larger than that of the underlying obligation, then the amount of eligible hedge is capped at 60% of the amount of the underlying obligation.

Only credit default swaps and total return swaps that provide credit protection equivalent to guarantees will be eligible for recognition. The following exception applies.

Where a bank buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record offsetting deterioration in the value of the asset that is protected (either through reductions in fair value or by an addition to reserves), the credit protection will not be recognized. The treatment of first- to-default and second-to-default products is covered separately in paragraphs 207 to 210, International Convergence of Capital Measurement and Capital Standards – June 2006

Other types of credit derivatives will not be eligible for recognition at this time.

(Refer para 191-194, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of 6.3 “Credit and Guarantee Derivatives” - Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

For Credit derivatives and guarantees, Materiality thresholds on payments below which no payment is made in the event of loss are equivalent to retained first loss positions and must be deducted in full from the capital of the bank purchasing the credit protection. (Refer para 197, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of 6.3 “Credit and Guarantee Derivatives” - Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Tranched cover

Where the bank transfers a portion of the risk of an exposure in one or more tranches to a protection seller or sellers and retains some level of risk of the loan and the risk transferred and the risk retained are of different seniority, banks may obtain credit protection for either the senior tranches (e.g. second loss portion) or the junior tranche (e.g. first loss portion). In this case the rules as set out in Section IV (Credit risk ─ securitization framework) will apply.

(Refer para 199, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of 6.3 “Credit and Guarantee Derivatives” - Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Currency mismatches

Where the credit protection is denominated in a currency different from that in which the exposure is denominated — i.e. there is a currency mismatch — the amount of the exposure deemed to be protected will be reduced by the application of a haircut HFX, i.e.

GA = G x (1 – HFX)

where:

G = nominal amount of the credit protection

HFX = haircut appropriate for currency mismatch between the credit protection and underlying obligation.

The appropriate haircut based on a 10-business day holding period (assuming daily marking-to- market) will be applied.

If a bank uses the supervisory haircuts, it will be 8%. The haircuts must be scaled up using the square root of time formula, depending on the frequency of revaluation of the credit protection as described in paragraph 168, International Convergence of Capital Measurement and Capital Standards – June 2006

(Refer para 200, International Convergence of Capital Measurement and Capital Standards – June 2006)

Chapter 6, Credit Risk Mitigation, Basel II SAMA guideline as a separate section 6.4 “Maturity Mismatch”, Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

For the purposes of calculating risk-weighted assets, a maturity mismatch occurs when the residual maturity of a hedge is less than that of the underlying exposure.

Definition of maturity

The maturity of the underlying exposure and the maturity of the hedge should both be defined conservatively. The effective maturity of the underlying should be gauged as the longest possible remaining time before the counterparty is scheduled to fulfil its obligation, taking into account any applicable grace period. For the hedge, embedded options which may reduce the term of the hedge should be taken into account so that the shortest possible effective maturity is used. Where a call is at the discretion of the protection seller, the maturity will always be at the first call date. If the call is at the discretion of the protection buying bank but the terms of the arrangement at origination of the hedge contain a positive incentive for the bank to call the transaction before contractual maturity, the remaining time to the first call date will be deemed to be the effective maturity. For example, where there is a step-up in cost in conjunction with a call feature or where the effective cost of cover increases over time even if credit quality remains the same or increases, the effective maturity will be the remaining time to the first call.

Risk weights for maturity mismatches

As outlined in paragraph 143 of the International Convergence of Capital Measurement and Capital Standards – June 2006, hedges with maturity mismatches are only recognized when their original maturities are greater than or equal to one year. As a result, the maturity of hedges for exposures with original maturities of less than one year must be matched to be recognized. In all cases, hedges with maturity mismatches will no longer be recognized when they have a residual maturity of three months or less.

When there is a maturity mismatch with recognized credit risk mitigants (collateral, on-balance sheet netting, guarantees and credit derivatives) the following adjustment will be applied.

Pa = P x (t – 0.25) / (T – 0.25)

where:

Pa = value of the credit protection adjusted for maturity mismatch

P = credit protection (e.g. collateral amount, guarantee amount) adjusted for any haircuts

t = min (T, residual maturity of the credit protection arrangement) expressed in years

T = min (5, residual maturity of the exposure) expressed in years

(Refer para 202-205, International Convergence of Capital Measurement and Capital Standards – June 2006)

Chapter 6, Credit Risk Mitigation, Basel II SAMA guideline as a separate section 6.5 “Other items related to the treatment of CRM techniques”, Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Treatment of pools of CRM techniques

In the case where a bank has multiple CRM techniques covering a single exposure (e.g. a bank has both collateral and guarantee partially covering an exposure), the bank will be required to subdivide the exposure into portions covered by each type of CRM technique (e.g. portion covered by collateral, portion covered by guarantee) and the risk-weighted assets of each portion must be calculated separately. When credit protection provided by a single protection provider has differing maturities, they must be subdivided into separate protection as well.

First-to-default credit derivatives

There are cases where a bank obtains credit protection for a basket of reference names and where the first default among the reference names triggers the credit protection and the credit event also terminates the contract. In this case, the bank may recognize regulatory capital relief for the asset within the basket with the lowest risk-weighted amount, but only if the notional amount is less than or equal to the notional amount of the credit derivative.

With regard to the bank providing credit protection through such an instrument, if the product has an external credit assessment from an eligible credit assessment institution, the risk weight in paragraph 567, International Convergence of Capital Measurement and Capital Standards – June 2006 applied to securitization tranches will be applied. If the product

Second-to-default credit derivatives

is not rated by an eligible external credit assessment institution, the risk weights of the assets included in the basket will be aggregated up to a maximum of 1250% and multiplied by the nominal amount of the protection provided by the credit derivative to obtain the risk-weighted asset amount.

In the case where the second default among the assets within the basket triggers the credit protection, the bank obtaining credit protection through such a product will only be able to recognize any capital relief if first-default-protection has also be obtained or when one of the assets within the basket has already defaulted.

For banks providing credit protection through such a product, the capital treatment is the same as in paragraph 208, International Convergence of Capital Measurement and Capital Standards – June 2006 with one exception.

The exception is that, in aggregating the risk weights, the asset with the lowest risk weighted amount can be excluded from the calculation.

(Refer para 206-210, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 33, Specialized lending (“SL”) exposures, 2.2.4, SAMA detailed guidance document relating to Pillar 1, June 2006:

The original paragraph was as follows:

The four sub-classes of SL are project finance, object finance, commodities finance and income-producing real estate, each of these sub-classes are considered below.

The new paragraph would read as follows:

The five sub-classes of specialized lending are project finance, object finance, commodities finance, income producing real estate, and high-volatility commercial real estate. Each of these sub-classes is defined below.

(Refer para 220, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Specialized lending (“SL”) exposures, Page 34, SAMA detailed guidance document relating to Pillar 1, June 2006, through insertion of a heading titled “High Volatility Commercial Real Estate” subsequent to Para 2.2.10

(This is in addition to existing text)

High-volatility commercial real estate (HVCRE) lending is the financing of commercial real estate that exhibits higher loss rate volatility (i.e. higher asset correlation) compared to other types of SL. HVCRE includes:

■

Commercial real estate exposures secured by properties of types that are categorized by the national supervisor as sharing higher volatilities in portfolio default rates;

■

Loans financing any of the land acquisition, development and construction (ADC) phases for properties of those types in such jurisdictions; and

■

Loans financing ADC of any other properties where the source of repayment at origination of the exposure is either the future uncertain sale of the property or cash flows whose source of repayment is substantially uncertain (e.g. the property has not yet been leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate), unless the borrower has substantial equity at risk. Commercial ADC loans exempted from treatment as HVCRE loans on the basis of certainty of repayment of borrower equity are, however, ineligible for the additional reductions for SL exposures described in paragraph 277, International Convergence of Capital Measurement and Capital Standards – June 2006

(Refer para 227, International Convergence of Capital Measurement and Capital Standards – June 2006)

(This is in addition to existing text)

Where SAMA would categories certain types of commercial real estate exposures as HVCRE in their jurisdictions, it would make public such determinations. SAMA would then ensure that such treatment is then applied equally to banks under their supervision when making such HVCRE loans in that jurisdiction

(Refer para 228, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 30, Section 1.3.6, SAMA detailed guidance document relating to Pillar 1, June 2006:

The original paragraph was as follows:

A bank must produce an implementation plan, specifying to what extent and when it intends to roll out IRB approaches across significant asset classes (or sub-classes in the case of retail) and business units over time.

The revised paragraph would be as follows:

The plan should be exacting, yet realistic, and must be agreed with the supervisor. It should be driven by the practicality and feasibility of moving to the more advanced approaches, and not motivated by a desire to adopt a Pillar 1 approach that minimizes its capital charge. During the roll-out period, supervisors will ensure that no capital relief is granted for intra-group transactions which are designed to reduce a banking group ‘s aggregate capital charge by transferring credit risk among entities on the standardized approach, foundation and advanced IRB approaches. This includes, but is not limited to, asset sales or cross guarantees.

(Refer para 258, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section 1.2, Application, page 29 SAMA detailed guidance document relating to Pillar 1, June 2006 SAMA detailed guidance document relating to Pillar 1, June 2006

Banks adopting an IRB approach are expected to continue to employ an IRB approach. A voluntary return to the standardized or foundation approach is permitted only in extraordinary circumstances, such as divestiture of a large fraction of the bank ‘s credit related business and must be approved by the supervisor.

(Refer para 261, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section for Criteria for transition to the IRB Approach – Page 54, SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Given the data limitations associated with SL exposures, a bank may remain on the supervisory slotting criteria approach for one or more of the PF, OF, CF, IPRE or HVCRE sub-classes, and move to the foundation or advanced approach for other sub-classes within the corporate asset class

(Refer para 262, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section for Criteria for transition to the IRB Approach – Page 54, SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Banks adopting the foundation or advanced approaches are required to calculate their capital requirement using these approaches, as well as the 1988 Accord for the time period specified in paragraphs 45 to 49, International Convergence of Capital Measurement and Capital Standards – June 2006

(Refer para 263, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section for Criteria for transition to the IRB Approach – Page 54, SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Under these transitional arrangements banks are required to have a minimum of two years of data at the implementation of this Framework. This requirement will increase by one year for each of three years of transition.

(Refer para 265, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Page 40, Section 4.1.10, 4.2 Risk components, Probability of default (PD), SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Banks (SAMA has disallowed the application of foundation or advanced approaches to HCVRE) must map their internal grades to five supervisory categories, each of which is associated with a specific risk weight. The slotting criteria on which this mapping must be based are the same as those for IPRE, as provided in Annex 6 International Convergence of Capital Measurement and Capital Standards – June 2006,. The risk weights associated with each category are: Supervisory categories and UL risk weights for high-volatility commercial real estate

Strong	Good	Satisfactory	Weak	Default
95%	120%	140%	250%	0%

(Refer para 280, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section, 5.2.1, Probability of default (PD) and loss given default (LGD), Basel II Page 45, - SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Banks may reflect the risk-reducing effects of guarantees and credit derivatives, either in support of an individual obligation or a pool of exposures, through an adjustment of either the PD or LGD estimate, subject to the minimum requirements in paragraphs 480 to 489 of the International Convergence of Capital Measurement and Capital Standards – June 2006. Whether adjustments are done through PD or LGD, they must be done in a consistent manner for a given guarantee or credit derivative type.

(Refer para 332, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section, 5.2.1, Probability of default (PD) and loss given default (LGD), Basel II Page 45, - SAMA detailed guidance document relating to Pillar 1, June 2006

(This is in addition to existing text)

Consistent with the requirements outlined above for corporate, sovereign, and bank exposures, banks must not include the effect of double default in such adjustments. The adjusted risk weight must not be less than that of a comparable direct exposure to the protection provider. Consistent with the standardized approach, banks may choose not to recognize credit protection if doing so would result in a higher capital requirement.

(Refer para 333, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 42, of 168, Section 4.2.6, Exposure at default (EAD), SAMA detailed guidance document relating to Pillar 1, June 2006-

The original paragraph was

4.2.6 The following paragraphs on EAD apply to both on- and off-balance sheet positions. All exposures are measured gross of specific provisions or partial write-offs. The EAD on drawn amounts should not be less than the sum of:

(i)

The amount by which a bank ‘s regulatory capital would be reduced if the exposure were written-off fully; and

(ii)

Any specific provisions and partial write-offs.

The revised paragraph would be as follows:

(i)

The amount by which a bank ‘s regulatory capital would be reduced if the exposure were written-off fully; and

(ii)

Any specific provisions and partial write-offs.

When the difference between the instrument ‘s EAD and the sum of (i) and (ii) is positive, this amount is termed a discount. The calculation of risk-weighted assets is independent of any discounts. Under the limited circumstances described in paragraph 380, International Convergence of Capital Measurement and Capital Standards – June 2006, discounts may be included in the measurement of total eligible provisions for purposes of the EL-provision calculation set out in Section III.G, International Convergence of Capital Measurement and Capital Standards – June 2006 SAMA hereby intimates that the approaches laid in Annexure 4 (Treatment of Counterparty Credit Risk and Cross-Product Netting), of the International Convergence of Capital Measurement and Capital Standards, 2006, (with the exception of clauses applicable to netting) for the purpose of computing the credit equivalent amount of Securities Financing Transactions and OTC derivatives that expose a bank to counterparty credit risk, are available to banks and constitute an integral part of the "SAMA Detailed Guidance Document Relating to Pillar 1, June 2006".

(Refer para 334, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 149, Section 7.2.1, MBA based Approach, SAMA detailed guidance document relating to Pillar 1, June 2006:

The original paragraph read as follows

Under the MBA, a bank would 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 revised paragraph would be as follows:

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)

To be read as part of 6.3 “Credit and Guarantee Derivatives” - Page 147 of the SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Banks are permitted to recognize guarantees but not collateral obtained on an equity position wherein the capital requirement is determined through use of the market-based approach.

(Refer para 349, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section 8.2, Rules for purchased receivables, page 151 of SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Foundation IRB treatment

If the purchasing bank is unable to decompose EL into its PD and LGD components in a reliable manner, the risk weight is determined from the corporate risk-weight function using the following specifications: if the bank can demonstrate that the exposures are exclusively senior claims to corporate borrowers, an LGD of 45% can be used. PD will be calculated by dividing the EL using this LGD. EAD will be calculated as the outstanding amount minus the capital charge for dilution prior to credit risk mitigation (KDilution). Otherwise, PD is the bank ‘s estimate of EL; LGD will be 100%; and EAD is the amount outstanding minus KDilution. EAD for a revolving purchase facility is the sum of the current amount of receivables purchased plus 75% of any undrawn purchase commitments minus KDilution. If the purchasing bank is able to estimate PD in a reliable manner, the risk weight is determined from the corporate risk-weight functions according to the specifications for LGD, M and the treatment of guarantees under the foundation approach as given in paragraphs 287 to 296, 299, 300 to 305, and 318, International Convergence of Capital Measurement and Capital Standards – June 2006.

(Refer para 366, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section 8.2, Rules for purchased receivables, page 151 of SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

Advanced IRB treatment

If the purchasing bank can estimate either the pool ‘s default-weighted average loss rates given default (as defined in paragraph 468) or average PD in a reliable manner, the bank may estimate the other parameter based on an estimate of the expected long-run loss rate. The bank may (i) use an appropriate PD estimate to infer the long-run default-weighted average loss rate given default, or (ii) use a long-run default-weighted average loss rate given default to infer the appropriate PD. In either case, it is important to recognize that the LGD used for the IRB capital calculation for purchased receivables cannot be less than the long-run default-weighted average loss rate given default and must be consistent with the concepts defined in paragraph 468. The risk weight for the purchased receivables will be determined using the bank ‘s estimated PD and LGD as inputs to the corporate risk-weight function. Similar to the foundation IRB treatment, EAD will be the amount outstanding minus KDilution. EAD for a revolving purchase facility will be the sum of the current amount of receivables purchased plus 75% of any undrawn purchase commitments minus KDilution (thus, banks using the advanced IRB approach will not be permitted to use their internal EAD estimates for undrawn purchase commitments).

(Refer para 367, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section 8.2, Rules for purchased receivables, page 151 of SAMA detailed guidance document relating to Pillar 1, June 2006:

(This is in addition to existing text)

For drawn amounts, M will equal the pool ‘s exposure-weighted average effective maturity (as defined in paragraphs 320 to 324, International Convergence of Capital Measurement and Capital Standards – June 2006). This same value of M will also be used for undrawn amounts under a committed purchase facility provided the facility contains effective covenants, early amortization triggers, or other features that protect the purchasing bank against a significant deterioration in the quality of the future receivables it is required to purchase over the facility ‘s term. Absent such effective protections, the M for undrawn amounts will be calculated as the sum of (a) the longest-dated potential receivable under the purchase agreement and (b) the remaining maturity of the purchase facility.

(Refer para 368, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 46, Section 6, Calculation of expected losses., SAMA detailed guidance document relating to Pillar 1, June 2006:

The original paragraph was as follows:

Banks should sum the EL amount (defined as EL multiplied by EAD) associated with their exposures.

The revised paragraph would be as follows:

A bank must sum the EL amount (defined as EL multiplied by EAD) associated with its exposures (excluding the EL amount associated with equity exposures under the PD/LGD approach and securitization exposures) to obtain a total EL amount. While the EL amount associated with equity exposures subject to the PD/LGD approach is excluded from the total EL amount, paragraphs 376 and 386, International Convergence of Capital Measurement and Capital Standards – June 2006 apply to such exposures. The treatment of EL for securitization exposures is described in paragraph 563, International Convergence of Capital Measurement and Capital Standards – June 2006.

(Refer para 375, International Convergence of Capital Measurement and Capital Standards – June 2006)

The following would be read as part of, Page 46, Section 6.2, Expected loss for SL exposures subject to the supervisory slotting criteria, SAMA detailed guidance document relating to Pillar 1, June 2006:

Supervisory categories and the risk weights for HVCRE:

The risk weights for HVCRE are as follows:

Strong	Good	Satisfactory	Weak	Default
5%	5%	35%	100%	625%

Even where, at national discretion, supervisors allow banks to assign preferential risk weights to HVCRE exposures falling into the "strong" and "good" supervisory categories as outlined in paragraph 282, the corresponding EL risk weight will remain at 5% for both "strong" and "good" exposures.

(Refer para 379, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 47, Section 6.4, Treatment of expected losses and provisions, SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows:

Where the total EL amount is less than total eligible provisions, the SAMA would generally allow banks to recognize the difference in supplementary capital up to a maximum of 0.6% of credit risk-weighted assets.

The revised paragraph would be as follows:

Where the calculated EL amount is lower than the provisions of the bank, its supervisors must consider whether the EL fully reflects the conditions in the market in which it operates before allowing the difference to be included in Tier 2 capital. If specific provisions exceed the EL amount on defaulted assets this assessment also needs to be made before using the difference to offset the EL amount on non-defaulted assets.

(Refer para 385, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 47, Section 6.4, Treatment of expected losses and provisions, SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows:

The EL amount for equity exposures under the PD/LGD approach is deducted from the capital base. Provisions or write-offs for equity exposure under the PD/LGD approach will not be used in the calculation of EL and provision calculation.

The revised paragraph would be as follows:

The EL amount for equity exposures under the PD/LGD approach is deducted 50% from Tier 1 and 50% from Tier 2. Provisions or write-offs for equity exposures under the PD/LGD approach will not be used in the EL-provision calculation.

The treatment of EL and provisions related to securitization exposures is outlined in paragraph 563.

(Refer para 386, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 81, Section 5.2.2, Integrity of rating process, Corporate, sovereign and bank exposures - SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows

Borrower and facility ratings should be reviewed and updated at least annually. Higher risk borrowers or problem exposures should be subject to more frequent review.

The revised paragraph would be as follows:

Borrowers and facilities must have their ratings refreshed at least on an annual basis. Certain credits, especially higher risk borrowers or problem exposures, must be subject to more frequent review. In addition, banks must initiate a new rating if material information on the borrower or facility comes to light.

(Refer para 425, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 104, Section 4.2.8, Re-ageing, SAMA detailed guidance document relating to Pillar 1, June 2006:

The original paragraph was as follows:

Re-ageing is a process by which the delinquency status of loans, the terms of which have not been changed, is adjusted based on subsequent good performance, even though not all arrears under the original repayment schedule have been paid off.

The following is added to the original paragraph:

The bank must have clearly articulated and documented policies in respect of the counting of days past due, in particular in respect of the re-ageing of the facilities and the granting of extensions, deferrals, renewals and rewrites to existing accounts. At a minimum, the re-ageing policy must include: (a) approval authorities and reporting requirements; (b) minimum age of a facility before it is eligible for re-ageing; (c) delinquency levels of facilities that are eligible for re-ageing; (d) maximum number of re-ageings per facility; and (e) a reassessment of the borrower ‘s capacity to repay. These policies must be applied consistently over time, and must support the 'use test‘ (i.e. if a bank treats a re-aged exposure in a similar fashion to other delinquent exposures more than the past-due cut off point, this exposure must be recorded as in default for IRB purposes). Some supervisors may choose to establish more specific requirements on re-ageing for banks in their jurisdiction.

(Refer para 458, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 104, Section 4.4.1, Data observation period - SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows:

Irrespective of whether a bank is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used should be at least 2 years for at least one source. If the available observation period spans a longer period for any source, and the data are relevant and material, this longer period should be used. Bank need not give equal importance to historical data if it can convince SAMA that more recent data are a better predictor of default rates.

The revised paragraph would be as follows:

Irrespective of whether a bank is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation period spans a longer period for any source, and this data are relevant and material, this longer period must be used.

(Refer para 463, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 104, Section 4.4.1, Data observation period, SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows:

The revised paragraph would be as follows:

Irrespective of whether banks are using external, internal, pooled data sources, or a combination of the three, for their estimation of loss characteristics, the length of the underlying historical observation period used must be at least five years.

If the available observation spans a longer period for any source, and these data are relevant, this longer period must be used. A bank need not give equal importance to historic data if it can convince its supervisor that more recent data are a better predictor of loss rates.

(Refer para 466, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 109, Section 4.6.7, Requirements specific to own-EAD estimates - SAMA detailed guidance document relating to Pillar 1, June 2006:

Original paragraph was as follows:

Due consideration should be paid by banks to their specific policies and strategies adopted in respect of account monitoring and payment processing. Banks should also consider their ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events. Banks should also have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per borrower and per grade. Banks should be able to monitor outstanding balances on a daily basis.

The revised paragraph would be as follows:

Due consideration must be paid by the bank to its specific policies and strategies adopted in respect of account monitoring and payment processing. The bank must also consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events. Banks must also have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per borrower and per grade. The bank must be able to monitor outstanding balances on a daily basis.

477(i).

For transactions that expose banks to counterparty credit risk, estimates of EAD must fulfil the requirements set forth in Annex 4 of this Framework.

(Refer para 477, International Convergence of Capital Measurement and Capital Standards – June 2006)

To be read as part of Section 4.5, Requirements specific to own-LGD estimates, page 106 of SAMA detailed guidance document relating to Pillar 1, June 2006:

In all cases, both the borrower and all recognized guarantors must be assigned a borrower rating at the outset and on an ongoing basis. A bank must follow all minimum requirements for assigning borrower ratings set out in this document, including the regular monitoring of the guarantor ‘s condition and ability and willingness to honor its obligations.

Consistent with the requirements in paragraphs 430 and 431, International Convergence of Capital Measurement and Capital Standards – June 2006, a bank must retain all relevant information on the borrower absent the guarantee and the guarantor. In the case of retail guarantees, these requirements also apply to the assignment of an exposure to a pool, and the estimation of PD.

(Refer para 481, International Convergence of Capital Measurement and Capital Standards – June 2006)

Chapter 6 - Credit Risk Mitigation - Collateral Management, Page 145 of SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraph was as following

The new Basel framework identifies two primary types of credit risk mitigation (CRM): guarantees and collateral. Guarantees are legally binding promises from a third party that the loan obligations of the borrower would be met. The conditions for a guarantee to be eligible are the same as those in current Accord requiring that they are direct, explicit, irrevocable and unconditional. Under the new Basel framework, eligible guarantees would also include additional operational requirements and a treatment for maturity mismatches. The principle of substitution has been retained from current requirements.

The following is added to the above:

The guarantee must be evidenced in writing, non-cancellable on the part of the guarantor, in force until the debt is satisfied in full (to the extent of the amount and tenor of the guarantee) and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgment. However, in contrast to the foundation approach to corporate, bank, and sovereign exposures, guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognized under certain conditions. Specifically, the onus is on the bank to demonstrate that the assignment criteria adequately address any potential reduction in the risk mitigation effect.

Under the new Basel framework, eligible guarantees would also include additional operational requirements and a treatment for maturity mismatches. The principle of substitution has been retained from current requirements (Refer para 484, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 157, 10.4.7, 10.4.8, Recognition of internally determined correlations, SAMA detailed guidance document relating to Pillar 1, June 2006:

Original Paragraphs were the following:

10.4.7

Recognition of internally determined correlations

The new Basel framework allows a national supervisory authority to decide whether to permit a bank to recognize diversification benefits (less than perfect correlation) across individual operational risk estimates within a bank group. The Bank must be able to prove to the supervisor that its systems for determining correlations are sound, implemented with integrity, and take into account the uncertainty surrounding any such correlation estimate (particularly in periods of stress). The bank should also validate its assumptions using appropriate quantitative and qualitative techniques. SAMA proposes to allow a Bank to use internally determined correlations across individual operational risk estimates provided that i) such co-relations meet back testing, stress testing and other validation requirements ii) and the bank ‘s internal estimates taken as a whole provide predictability for determining regulatory capital requirements.

10.4.8

Calculation of operational risk capital to UL only

The new Basel framework requires a bank to calculate its regulatory capital requirement as the sum of expected loss (EL) and unexpected loss (UL), unless the bank can demonstrate to the satisfaction of its national supervisory authority that it has measured and accounted for its EL exposure.

SAMA proposes to permit a bank to hold capital against UL only provided that the Bank can demonstrate to SAMA that it has accounted for its EL exposure.

The revised paragraph would be as follows:

This paragraph describes a series of quantitative standards that will apply to internally generated operational risk measures for purposes of calculating the regulatory minimum capital charge.

(a)

Any internal operational risk measurement system must be consistent with the scope of operational risk defined by the Committee in paragraph 644, International Convergence of Capital Measurement and Capital Standards – June 2006, and the loss event types defined in Annex 9, International Convergence of Capital Measurement and Capital Standards – June 2006

(b)

Supervisors will require the bank to calculate its regulatory capital requirement as the sum of expected loss (EL) and unexpected loss (UL), unless the bank can demonstrate that it is adequately capturing EL in its internal business practices. That is, to base the minimum regulatory capital requirement on UL alone, the bank must be able to demonstrate to the satisfaction of its national supervisor that it has measured and accounted for its EL exposure.

(c)

A bank ‘s risk measurement system must be sufficiently 'granular 'to capture the major drivers of operational risk affecting the shape of the tail of the loss estimates.

(d)

Risk measures for different operational risk estimates must be added for purposes of calculating the regulatory minimum capital requirement. However, the bank may be permitted to use internally determined correlations in operational risk losses across individual operational risk estimates, provided it can demonstrate to the satisfaction of the national supervisor that its systems for determining correlations are sound, implemented with integrity, and take into account the uncertainty surrounding any such correlation estimates (particularly in periods of stress). The bank must validate its correlation assumptions using appropriate quantitative and qualitative techniques.

(e)

Any operational risk measurement system must have certain key features to meet the supervisory soundness standard set out in this section. These elements must include the use of internal data, relevant external data, scenario analysis and factors reflecting the business environment and internal control systems.

(f)

A bank needs to have a credible, transparent, well-documented and verifiable approach for weighting these fundamental elements in its overall operational risk measurement system. For example, there may be cases where estimates of the 99.9th percentile confidence interval based primarily on internal and external loss event data would be unreliable for business lines with a heavy-tailed loss distribution and a small number of observed losses. In such cases, scenario analysis, and business environment and control factors, may play a more dominant role in the risk measurement system. Conversely, operational loss event data may play a more dominant role in the risk measurement system for business lines where estimates of the 99.9th percentile confidence interval based primarily on such data are deemed reliable. In all cases, the bank ‘s approach for weighting the four fundamental elements should be internally consistent and avoid the double counting of qualitative assessments or risk mitigants already recognized in other elements of the framework.

(Refer para 669, International Convergence of Capital Measurement and Capital Standards – June 2006)

Page 155, 10.4, Partial Use, SAMA detailed guidance document relating to Pillar 1, June 2006: Original Paragraph was the following:

[680-683] The new Basel framework permits a Basic Indicator Approach, a Standardized Approach and an Advanced Management Approach (AMA). SAMA initially expects banks to move to the Basic Indicator or the Standardized Approach and thereafter to the more advanced AMA approach supervisor. However, the new Basel framework also permits banks to use an AMA for some parts of its operations and the Basic Indicator Approach or Standardized Approach for the balance ("partial use"), on both a transitional and permanent basis, subject to certain conditions.

These conditions include:

•

On implementation date, a significant part of the Banks operational risk should be captured by the AMA, and;

•

The Bank must provide a timetable outlining how it intends to roll out the AMA across all but on immaterial part of its operations. A Bank may determine which parts of its operations would use an AMA based on a business line, legal entity, geographical or other internally determined basis.

The revised paragraph would be as follows:

680-683] The new Basel framework permits a Basic Indicator Approach, a Standardized Approach and an Advanced Management Approach (AMA). SAMA initially expects banks to move to the Basic Indicator or the Standardized Approach and thereafter to the more advanced AMA approach supervisor. However, the new Basel framework also permits banks to use an AMA for some parts of its operations and the Basic Indicator Approach or Standardized Approach for the balance ("partial use"), on both a transitional and permanent basis, subject to certain conditions.

These conditions include:

•

All operational risks of the bank ‘s global, consolidated operations are captured;

•

All of the bank ‘s operations that are covered by the AMA meet the qualitative criteria for using an AMA, while those parts of its operations that are using one of the simpler approaches meet the qualifying criteria for that approach;

•

On implementation date, a significant part of the Banks operational risk should be captured by the AMA, and;

•

(Refer para 680-683, International Convergence of Capital Measurement and Capital Standards – June 2006)

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