Page 31 of the GN 4 – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012:
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Original paragraph (130) to be deleted:
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| 130. | A Bank relying on its own estimates of LGD has the option to adopt the treatment for Bank using the foundation IRB approach (see paragraphs 126 to 128, International Convergence of Capital Measurement and Capital Standards – June 2006), or to make an adjustment to its LGD estimate of the exposure to reflect the presence of the recognized guarantee/credit derivative contract under the advanced IRB approach.
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Revised paragraph would read as follows:
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A bank relying on own-estimates of LGD has the option to adopt the treatment outlined above for banks under the foundation IRB approach (paragraphs 302 to 305, International Convergence of Capital Measurement and Capital Standards – June 2006), or to make an adjustment to its LGD estimate of the exposure to reflect the presence of the guarantee or credit derivative. Under this option, there are no limits to the range of eligible guarantors although the set of minimum requirements provided in paragraphs 483 and 484, International Convergence of Capital Measurement and Capital Standards – June 2006, concerning the type of guarantee must be satisfied. For credit derivatives, the requirements of paragraphs 488 and 489, International Convergence of Capital Measurement and Capital Standards – June 2006, must be satisfied. (When credit derivatives do not cover the restructuring of the underlying obligation, the partial recognition set out in paragraph 192, International Convergence of Capital Measurement and Capital Standards – June 2006, applies.)
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Operational requirements for recognition of double default
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| 130(i). | A bank using an IRB approach has the option of using the substitution approach in determining the appropriate capital requirement for an exposure. However, for exposures hedged by one of the following instruments the double default framework according to paragraphs 284 (i) to 284 (iii), International Convergence of Capital Measurement and Capital Standards – June 2006, may be applied subject to the additional operational requirements set out in paragraph 307 (ii), International Convergence of Capital Measurement and Capital Standards – June 2006. A bank may decide separately for each eligible exposure to apply either the double default framework or the substitution approach.
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| (a) | Single-name, unfunded credit derivatives (e.g. credit default swaps) or single- name guarantees.
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| (b) | First-to-default basket products — the double default treatment will be applied to the asset within the basket with the lowest risk-weighted amount.
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| (c) | nth-to-default basket products — the protection obtained is only eligible for consideration under the double default framework if eligible (n-1)th default protection has also been obtained or where (n-1) of the assets within the basket have already defaulted.
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| 130(ii). | The double default framework is only applicable where the following conditions are met.
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| (a) | The risk weight that is associated with the exposure prior to the application of the framework does not already factor in any aspect of the credit protection.
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| (b) | The entity selling credit protection is a bank, (This does not include PSEs and MDBs, even though claims on these may be treated as claims on banks according to paragraph 230, International Convergence of Capital Measurement and Capital Standards – June 2006) investment firm or insurance company (but only those that are in the business of providing credit protection, including mono-lines, re-insurers, and non-sovereign credit export agencies - By nonsovereign it is meant that credit protection in question does not benefit from any explicit sovereign counter-guarantee.), referred to as a financial firm, that:
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| ■ | is regulated in a manner broadly equivalent to that in this Framework (where there is appropriate supervisory oversight and transparency/ market discipline), or externally rated as at least investment grade by a credit rating agency deemed suitable for this purpose by supervisors;
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| ■ | had an internal rating with a PD equivalent to or lower than that associated with an external A- rating at the time the credit protection for an exposure was first provided or for any period of time thereafter; and •has an internal rating with a PD equivalent to or lower than that associated with an external investment-grade rating.
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| (c) | The underlying obligation is:
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| ■ | a corporate exposure as defined in paragraphs 218 to 228, International Convergence of Capital Measurement and Capital Standards – June 2006, (excluding specialised lending exposures for which the supervisory slotting criteria approach described in paragraphs 275 to 282, International Convergence of Capital Measurement and Capital Standards – June 2006, is being used); or
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| ■ | A claim on a PSE that is not a sovereign exposure as defined in paragraph 229, International Convergence of Capital Measurement and Capital Standards – June 2006; or
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| ■ | A loan extended to a small business and classified as a retail exposure as defined in paragraph 231, International Convergence of Capital Measurement and Capital Standards – June 2006.
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| (d) | The underlying obligor is not:
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| ■ | A financial firm as defined in (b); or
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| ■ | A member of the same group as the protection provider.
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| (e) | The credit protection meets the minimum operational requirements for such instruments as outlined in paragraphs 189 to 193, International Convergence of Capital Measurement and Capital Standards – June 2006.
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| (f) | In keeping with paragraph 190, International Convergence of Capital Measurement and Capital Standards – June 2006, for guarantees, for any recognition of double default effects for both guarantees and credit derivatives a bank must have the right and expectation to receive payment from the credit protection provider without having to take legal action in order to pursue the counterparty for payment. To the extent possible, a bank should take steps to satisfy itself that the protection provider is willing to pay promptly if a credit event should occur.
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| (g) | The purchased credit protection absorbs all credit losses incurred on the hedged portion of an exposure that arise due to the credit events outlined in the contract.
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| (h) | If the payout structure provides for physical settlement, then there must be legal certainty with respect to the deliverability of a loan, bond, or contingent liability. If a bank intends to deliver an obligation other than the underlying exposure, it must ensure that the deliverable obligation is sufficiently liquid so that the bank would have the ability to purchase it for delivery in accordance with the contract.
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| (i) | The terms and conditions of credit protection arrangements must be legally confirmed in writing by both the credit protection provider and the bank.
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| (j) | In the case of protection against dilution risk, the seller of purchased receivables must not be a member of the same group as the protection provider.
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| (k) | There is no excessive correlation between the creditworthiness of a protection provider and the obligor of the underlying exposure due to their performance being dependent on common factors beyond the systematic risk factor. The bank has a process to detect such excessive correlation. An example of a situation in which such excessive correlation would arise is when a protection provider guarantees the debt of a supplier of goods or services and the supplier derives a high proportion of its income or revenue from the protection provider.
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(Please refer to Paragraph 307 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The advanced approaches have been laid out on page 13 of the GN 4 – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012:
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The original paragraph (60) was follows
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| (a) | Market-based approach
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| 60. | Under this approach, a Bank is permitted to calculate the risk-weighted amount of its equity exposures held in the banking book using one or both of the following two separate and distinct methods:
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| (i) | Simple risk-weight method
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A 300% risk-weight is to be applied to equity exposure in a publicly traded company (being an equity security traded on a recognized exchange)1 and a 400% risk-weight is to be applied to all other equity exposures.
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1 For the definition of recognized exchange refer to SAMA's guidance document concerning the market risk issued in January 2004.
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Short positions in an equity exposure (including derivative instruments) held in the banking book are permitted to offset long positions in the same equity exposure, provided that these short positions have been explicitly designated as a hedge of the long positions in that equity exposure and that they have a remaining maturity of at least one year. Other short positions (including the net short position remains after the set-off) are to be treated as if they were long positions with the relevant risk-weight applied to the absolute value of each position.
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The following content would be deemed added to the original paragraph as a continuation:
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In the context of maturity mismatched positions, the methodology is that for corporate exposures
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(Please refer to Paragraph 345 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The advanced approaches have been laid out on page 31 of the GN 4 – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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The following is added to para 133 of the GN 4 – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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For retail exposures, where guarantees exist, either in support of an individual obligation or a pool of exposures, a bank may reflect the risk-reducing effect either through its estimates of PD or LGD, provided this is done consistently. In adopting one or the other technique, a bank must adopt a consistent approach, both across types of guarantees and over time.
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(Please refer to Paragraph 480 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The following text should be considered as added to Paragraph 129, page 31 of the GN 4 “Advanced IRB Approach” – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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There are no restrictions on the types of eligible guarantors. The bank must, however, have clearly specified criteria for the types of guarantors it will recognise for regulatory capital purposes.
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(Please refer to Paragraph 483 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The following text is a new Paragraph 129-A “adjustment criteria for advanced approach”, page 31 of the GN 4 “Advanced IRB Approach” – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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A bank must have clearly specified criteria for adjusting borrower grades or LGD estimates (or in the case of retail and eligible purchased receivables, the process of allocating exposures to pools) to reflect the impact of guarantees for regulatory capital purposes. These criteria must be as detailed as the criteria for assigning exposures to grades consistent with paragraphs 410 and 411, International Convergence of Capital Measurement and Capital Standards – June 2006 and must follow all minimum requirements for assigning borrower or facility ratings set out in this document. The criteria must be plausible and intuitive, and must address the guarantor‘s ability and willingness to perform under the guarantee. The criteria must also address the likely timing of any payments and the degree to which the guarantor‘s ability to perform under the guarantee is correlated with the borrower‘s ability to repay. The bank‘s criteria must also consider the extent to which residual risk to the borrower remains, for example a currency mismatch between the guarantee and the underlying exposure.
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In adjusting borrower grades or LGD estimates (or in the case of retail and eligible purchased receivables, the process of allocating exposures to pools), banks must take all relevant available information into account.
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(Please refer to Paragraph 485-487 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The following text is a new Paragraph 129 B “Credit derivatives - Advanced IRB Approach”, page 31 of the GN 4 “Advanced IRB Approach” – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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The minimum requirements for guarantees are relevant also for single-name credit derivatives. Additional considerations arise in respect of asset mismatches. The criteria used for assigning adjusted borrower grades or LGD estimates (or pools) for exposures hedged with credit derivatives must require that the asset on which the protection is based (the reference asset) cannot be different from the underlying asset, unless the conditions outlined in the foundation approach are met.
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In addition, the criteria must address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. The bank must also consider the extent to which other forms of residual risk remain.
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(Please refer to Paragraph 488 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The following text is a new Paragraph 129 C “For banks using foundation LGD estimates”, page 31 of the GN 4 “Advanced IRB Approach” – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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The minimum requirements outlined in paragraphs 480 to 489, International Convergence of Capital Measurement and Capital Standards – June 2006, apply to banks using the foundation LGD estimates with the following exceptions:
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| (1) | The bank is not able to use an ‗LGD-adjustment‘ option; and
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| (2) | The range of eligible guarantees and guarantors is limited to those outlined in BIS guidelines outlined in paragraph 302, International Convergence of Capital Measurement and Capital Standards – June 2006.
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(Please refer to Paragraph 490 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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The following text is a new subheading (c) “Requirements specific to estimating PD and LGD (or EL) for qualifying purchased receivables ” main heading “Purchased Receivables”, New Para 75 A, page 17 of the GN 4 “Advanced IRB Approach” – IRB Approach – Section C Prudential Returns General Guidance on IRB Approaches - January 2012
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Requirements specific to estimating PD and LGD (or EL) for qualifying purchased receivables
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The following minimum requirements for risk quantification must be satisfied for any purchased receivables (corporate or retail) making use of the top-down treatment of default risk and/or the IRB treatments of dilution risk.
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The purchasing bank will be required to group the receivables into sufficiently homogeneous pools so that accurate and consistent estimates of PD and LGD (or EL) for default losses and EL estimates of dilution losses can be determined. In general, the risk bucketing process will reflect the seller‘s underwriting practices and the heterogeneity of its customers. In addition, methods and data for estimating PD, LGD, and EL must comply with the existing risk quantification standards for retail exposures. In particular, quantification should reflect all information available to the purchasing bank regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing bank, or by external sources. The purchasing bank must determine whether the data provided by the seller are consistent with expectations agreed upon by both parties concerning, for example, the type, volume and on-going quality of receivables purchased.
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Where this is not the case, the purchasing bank is expected to obtain and rely upon more relevant data.
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Minimum operational requirements
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A bank purchasing receivables has to justify confidence that current and future advances can be repaid from the liquidation of (or collections against) the receivables pool. To qualify for the top-down treatment of default risk, the receivable pool and overall lending relationship should be closely monitored and controlled. Specifically, a bank will have to demonstrate the following:
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Legal certainty
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| ■ | The structure of the facility must ensure that under all foreseeable circumstances the bank has effective ownership and control of the cash remittances from the receivables, including incidences of seller or servicer distress and bankruptcy. When the obligor makes payments directly to a seller or servicer, the bank must verify regularly that payments are forwarded completely and within the contractually agreed terms. As well, ownership over the receivables and cash receipts should be protected against bankruptcy ‗stays‘ or legal challenges that could materially delay the lender‘s ability to liquidate/assign the receivables or retain control over cash receipts.
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Effectiveness of monitoring systems
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The bank must be able to monitor both the quality of the receivables and the financial condition of the seller and servicer. In particular:
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| ■ | The bank must (a) assess the correlation among the quality of the receivables and the financial condition of both the seller and servicer, and (b) have in place internal policies and procedures that provide adequate safeguards to protect against such contingencies, including the assignment of an internal risk rating for each seller and servicer.
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| ■ | The bank must have clear and effective policies and procedures for determining seller and servicer eligibility. The bank or its agent must conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller/servicer, detect fraud or operational weaknesses, and verify the quality of the seller‘s credit policies and servicer‘s collection policies and procedures. The findings of these reviews must be well documented.
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| ■ | The bank must have the ability to assess the characteristics of the receivables pool, including (a) over-advances; (b) history of the seller‘s arrears, bad debts, and bad debt allowances; (c) payment terms, and (d) potential contra accounts.
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| ■ | The bank must have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across receivables pools.
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| ■ | The bank must receive timely and sufficiently detailed reports of receivables ageings and dilutions to (a) ensure compliance with the bank‘s eligibility criteria and advancing policies governing purchased receivables, and (b) provide an effective means with which to monitor and confirm the seller‘s terms of sale (e.g. invoice date ageing) and dilution.
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Effectiveness of work-out systems
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An effective programme requires systems and procedures not only for detecting deterioration in the seller‘s financial condition and deterioration in the quality of the receivables at an early stage, but also for addressing emerging problems pro-actively. In particular,
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| ■ | The bank should have clear and effective policies, procedures, and information systems to monitor compliance with (a) all contractual terms of the facility (including covenants, advancing formulas, concentration limits, early amortisation triggers, etc.) as well as (b) the bank‘s internal policies governing advance rates and receivables eligibility. The bank‘s systems should track covenant violations and waivers as well as exceptions to established policies and procedures.
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| ■ | To limit inappropriate draws, the bank should have effective policies and procedures for detecting, approving, monitoring, and correcting over-advances.
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| ■ | The bank should have effective policies and procedures for dealing with financially weakened sellers or servicers and/or deterioration in the quality of receivable pools.
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| ■ | These include, but are not necessarily limited to, early termination triggers in revolving facilities and other covenant protections, a structured and disciplined approach to dealing with covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem receivables.
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Effectiveness of systems for controlling collateral, credit availability, and cash
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The bank must have clear and effective policies and procedures governing the control of receivables, credit, and cash. In particular,
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| ■ | Written internal policies must specify all material elements of the receivables purchase programme, including the advancing rates, eligible collateral, necessary documentation, concentration limits, and how cash receipts are to be handled. These elements should take appropriate account of all relevant and material factors, including the seller‘s/servicer‘s financial condition, risk concentrations, and trends in the quality of the receivables and the seller‘s customer base.
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| ■ | Internal systems must ensure that funds are advanced only against specified supporting collateral and documentation (such as servicer attestations, invoices, shipping documents, etc.).
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Compliance with the bank’s internal policies and procedures
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Given the reliance on monitoring and control systems to limit credit risk, the bank should have an effective internal process for assessing compliance with all critical policies and procedures, including
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| ■ | Regular internal and/or external audits of all critical phases of the bank‘s receivables purchase programme.
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| ■ | Verification of the separation of duties (i) between the assessment of the seller/servicer and the assessment of the obligor and (ii) between the assessment of the seller/servicer and the field audit of the seller/servicer.
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A bank‘s effective internal process for assessing compliance with all critical policies and procedures should also include evaluations of back office operations, with particular focus on qualifications, experience, staffing levels, and supporting systems
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(Please refer to Paragraph 491-499 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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Page 14 of the GN 4 “(ii) Internal models method” – IRB Approach – Section F “Equity Exposure” Prudential Returns General Guidance on IRB Approaches - January 2012
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The original paragraphs were as follows:
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| (ii) | Internal models method
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A Bank may use its internal models to calculate the risk-weighted amount of its equity exposures, subject to fulfilling the relevant requirements set out in the Rules described in SAMA's documents relating to the market risk amendment of 2004.
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Under this method, the Bank should calculate the risk-weighted amount of its equity exposures by multiplying the potential loss of its equity exposures as derived by using its internal models (e.g. VaR models) subject to the one-tailed 99% confidence interval of the difference between quarterly returns of the exposures and an appropriate risk-free rate computed over a long-term observation period (i.e. not less than three years) by 12.5. The risk-weighted amount calculated under the internal models method should be no less than the risk-weighted amount calculated under the simple risk weight method using a 200% risk-weight for equity exposure in a publicly traded company and a 300% risk weight for all other equity exposures. Such minimum risk-weighted amount should be calculated separately using the simple risk-weight method at individual exposure level rather than at portfolio level.
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The revised paragraph would read as follows
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Internal Models Market Basic Approach
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To be eligible for the internal models market-based approach a bank must demonstrate to its supervisor that it meets certain quantitative and qualitative minimum requirements at the outset and on an ongoing basis. A bank that fails to demonstrate continued compliance with the minimum requirements must develop a plan for rapid return to compliance, obtain its supervisor‘s approval of the plan, and implement that plan in a timely fashion. In the interim, banks would be expected to compute capital charges using a simple risk weight approach.
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Capital charge risk and quantification
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The following minimum quantitative standards apply for the purpose of calculating minimum capital charges under the internal models approach.
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| ■ | The capital charge is equivalent to the potential loss on the institution‘s equity portfolio arising from an assumed instantaneous shock equivalent to the 99th percentile, one-tailed confidence interval of the difference between quarterly returns and an appropriate risk-free rate computed over a long-term sample period.
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| ■ | The estimated losses should be robust to adverse market movements relevant to the long-term risk profile of the institution‘s specific holdings. The data used to represent return distributions should reflect the longest sample period for which data are available and meaningful in representing the risk profile of the bank‘s specific equity holdings. The data used should be sufficient to provide conservative, statistically reliable and robust loss estimates that are not based purely on subjective or judgmental considerations. Institutions must demonstrate to supervisors that the shock employed provides a conservative estimate of potential losses over a relevant long-term market or business cycle. Models estimated using data not reflecting realistic ranges of long-run experience, including a period of reasonably severe declines in equity market values relevant to a bank‘s holdings, are presumed to produce optimistic results unless there is credible evidence of appropriate adjustments built into the model. In the absence of built-in adjustments, the bank must combine empirical analysis of available data with adjustments based on a variety of factors in order to attain model outputs that achieve appropriate realism and conservatism. In constructing Value at Risk (VaR) models estimating potential quarterly losses, institutions may use quarterly data or convert shorter horizon period data to a quarterly equivalent using an analytically appropriate method supported by empirical evidence. Such adjustments must be applied through a well-developed and well-documented thought process and analysis. In general, adjustments must be applied conservatively and consistently over time. Furthermore, where only limited data are available, or where technical limitations are such that estimates from any single method will be of uncertain quality, banks must add appropriate margins of conservatism in order to avoid over-optimism.
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| ■ | No particular type of VaR model (e.g. variance-covariance, historical simulation, or Monte Carlo) is prescribed. However, the model used must be able to capture adequately all of the material risks embodied in equity returns including both the general market risk and specific risk exposure of the institution‘s equity portfolio. Internal models must adequately explain historical price variation, capture both the magnitude and changes in the composition of potential concentrations, and be robust to adverse market environments. The population of risk exposures represented in the data used for estimation must be closely matched to or at least comparable with those of the bank‘s equity exposures.
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| ■ | Banks may also use modelling techniques such as historical scenario analysis to determine minimum capital requirements for banking book equity holdings. The use of such models is conditioned upon the institution demonstrating to its supervisor that the methodology and its output can be quantified in the form of the loss percentile specified under (a).
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| ■ | Institutions must use an internal model that is appropriate for the risk profile and complexity of their equity portfolio. Institutions with material holdings with values that are highly non-linear in nature (e.g. equity derivatives, convertibles) must employ an internal model designed to capture appropriately the risks associated with such instruments.
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| ■ | Subject to supervisory review, equity portfolio correlations can be integrated into a bank‘s internal risk measures. The use of explicit correlations (e.g. utilisation of a variance/covariance VaR model) must be fully documented and supported using empirical analysis. The appropriateness of implicit correlation assumptions will be evaluated by supervisors in their review of model documentation and estimation techniques.
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| ■ | Mapping of individual positions to proxies, market indices, and risk factors should be plausible, intuitive, and conceptually sound. Mapping techniques and processes should be fully documented, and demonstrated with both theoretical and empirical evidence to be appropriate for the specific holdings. Where professional judgement is combined with quantitative techniques in estimating a holding‘s return volatility, the judgement must take into account the relevant and material information not considered by the other techniques utilised.
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| ■ | Where factor models are used, either single or multi-factor models are acceptable depending upon the nature of an institution‘s holdings. Banks are expected to ensure that the factors are sufficient to capture the risks inherent in the equity portfolio. Risk factors should correspond to the appropriate equity market characteristics (for example, public, private, market capitalisation industry sectors and sub-sectors, operational characteristics) in which the bank holds significant positions. While banks will have discretion in choosing the factors, they must demonstrate through empirical analyses the appropriateness of those factors, including their ability to cover both general and specific risk.
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| ■ | Estimates of the return volatility of equity investments must incorporate relevant and material available data, information, and methods. A bank may utilise independently reviewed internal data or data from external sources (including pooled data). The number of risk exposures in the sample, and the data period used for quantification must be sufficient to provide the bank with confidence in the accuracy and robustness of its estimates. Institutions should take appropriate measures to limit the potential of both sampling bias and survivorship bias in estimating return volatilities.
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| ■ | Risk Management processes and controls
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A rigorous and comprehensive stress-testing programme must be in place. Banks are expected to subject their internal model and estimation procedures, including volatility computations, to either hypothetical or historical scenarios that reflect worst-case losses given underlying positions in both public and private equities. At a minimum, stress tests should be employed to provide information about the effect of tail events beyond the level of confidence assumed in the internal models approach.
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Banks‘ overall risk management practices used to manage their banking book equity investments are expected to be consistent with the evolving sound practice guidelines issued by the Committee and national supervisors. With regard to the development and use of internal models for capital purposes, institutions must have established policies, procedures, and controls to ensure the integrity of the model and modelling process used to derive regulatory capital standards.
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These policies, procedures, and controls should include the following:
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| ■ | Full integration of the internal model into the overall management information systems of the institution and in the management of the banking book equity portfolio. Internal models should be fully integrated into the institution‘s risk management infrastructure including use in: (i) establishing investment hurdle ratesand evaluating alternative investments; (ii) measuring and assessing equity portfolio performance (including the risk-adjusted performance); and (iii) allocating economic capital to equity holdings and evaluating overall capital adequacy as required under Pillar 2. The institution should be able to demonstrate, through for example, investment committee minutes, that internal model output plays an essential role in the investment management process.
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| ■ | Established management systems, procedures, and control functions for ensuring the periodic and independent review of all elements of the internal modelling process, including approval of model revisions, vetting of model inputs, and review of model results, such as direct verification of risk computations. Proxy and mapping techniques and other critical model components should receive special attention. These reviews should assess the accuracy, completeness, and appropriateness of model inputs and results and focus on both finding and limiting potential errors associated with known weaknesses and identifying unknown model weaknesses. Such reviews may be conducted as part of internal or external audit programmes, by an independent risk control unit, or by an external third party.
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| ■ | Adequate systems and procedures for monitoring investment limits and the risk exposures of equity investments.
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| ■ | The units responsible for the design and application of the model must be functionally independent from the units responsible for managing individual investments.
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| ■ | Parties responsible for any aspect of the modelling process must be adequately qualified. Management must allocate sufficient skilled and competent resources to the modelling function.
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Under this method, the Bank should calculate the risk-weighted amount of its equity exposures by multiplying the potential loss of its equity exposures as derived by using its internal models (e.g. VaR models) subject to the one-tailed 99% confidence interval of the difference between quarterly returns of the exposures and an appropriate risk-free rate computed over a long-term observation period (i.e. not less than three years) by 12.5.
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The risk-weighted amount calculated under the internal models method should be no less than the risk-weighted amount calculated under the simple risk weight method using a 200% risk-weight for equity exposure in a publicly traded company and a 300% risk-weight for all other equity exposures. Such minimum risk-weighted amount should be calculated separately using the simple risk-weight method at individual exposure level rather than at portfolio level.
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(Please refer to Paragraph 525, 527 and 528 of International Convergence of Capital Measurement and Capital Standards – June 2006)
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