Operational requirements for eligible commercial or residential real estate
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| 16.130 | Subject to meeting the definition above, commercial and residential real estate will be eligible for recognition as collateral for corporate claims only if all of the following operational requirements are met.
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| | (1) | Legal enforceability: any claim on collateral taken must be legally enforceable in all relevant jurisdictions, and any claim on collateral must be properly filed on a timely basis. Collateral interests must reflect a perfected lien (i.e. all legal requirements for establishing the claim have been fulfilled). Furthermore, the collateral agreement and the legal process underpinning it must be such that they provide for the bank to realize the value of the collateral within a reasonable timeframe.
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| | (2) | Objective market value of collateral: the collateral must be valued at or less than the current fair value under which the property could be sold under private contract between a willing seller and an arm’s-length buyer on the date of valuation.
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| | (3) | Frequent revaluation: the bank is expected to monitor the value of the collateral on a frequent basis and at a minimum once every year. More frequent monitoring is suggested where the market is subject to significant changes in conditions. Statistical methods of evaluation (e.g. reference to house price indices, sampling) may be used to update estimates or to identify collateral that may have declined in value and that may need re- appraisal. A qualified professional must evaluate the property when information indicates that the value of the collateral may have declined materially relative to general market prices or when a credit event, such as default, occurs.
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| | (4) | Junior liens: In some member countries, eligible collateral will be restricted to situations where the lender has a first charge over the property. Junior liens may be taken into account where there is no doubt that the claim for collateral is legally enforceable and constitutes an efficient credit risk mitigant. Where junior liens are recognized the bank must first take the haircut value of the collateral, then reduce it by the sum of all loans with liens that rank higher than the junior lien, the remaining value is the collateral that supports the loan with the junior lien. In cases where liens are held by third parties that rank pari passu with the lien of the bank, only the proportion of the collateral (after the application of haircuts and reductions due to the value of loans with liens that rank higher than the lien of the bank) that is attributable to the bank may be recognized.
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| 16.131 | Additional collateral management requirements are as follows:
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| | (1) | The types of commercial and residential real estate collateral accepted by the bank and lending policies (advance rates) when this type of collateral is taken must be clearly documented.
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| | (2) | The bank must take steps to ensure that the property taken as collateral is adequately insured against damage or deterioration.
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| | (3) | The bank must monitor on an ongoing basis the extent of any permissible prior claims (e.g. tax) on the property.
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| | (4) | The bank must appropriately monitor the risk of environmental liability arising in respect of the collateral, such as the presence of toxic material on a property.
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Requirements for recognition of financial receivables : definition of eligible receivables
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| 16.132 | Eligible financial receivables are claims with an original maturity of less than or equal to one year where repayment will occur through the commercial or financial flows related to the underlying assets of the borrower. This includes both self-liquidating debt arising from the sale of goods or services linked to a commercial transaction and general amounts owed by buyers, suppliers, renters, national and local governmental authorities, or other non-affiliated parties not related to the sale of goods or services linked to a commercial transaction. Eligible receivables do not include those associated with securitizations, sub- participations or credit derivatives.
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Requirements for recognition of financial receivables: legal certainty
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| 16.133 | The legal mechanism by which collateral is given must be robust and ensure that the lender has clear rights over the proceeds from the collateral.
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| 16.134 | Banks must take all steps necessary to fulfil local requirements in respect of the enforceability of security interest, e.g. by registering a security interest with a registrar. There should be a framework that allows the potential lender to have a perfected first priority claim over the collateral.
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| 16.135 | All documentation used in collateralized transactions 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.
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| 16.136 | The collateral arrangements must be properly documented, with a clear and robust procedure for the timely collection of collateral proceeds. Banks’ procedures should ensure that any legal conditions required for declaring the default of the customer and timely collection of collateral are observed. In the event of the obligor’s financial distress or default, the bank should have legal authority to sell or assign the receivables to other parties without consent of the receivables’ obligors.
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Requirements for recognition of financial receivables: risk management
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| 16.137 | The bank must have a sound process for determining the credit risk in the receivables. Such a process should include, among other things, analyses of the borrower’s business and industry (e.g. effects of the business cycle) and the types of customers with whom the borrower does business. Where the bank relies on the borrower to ascertain the credit risk of the customers, the bank must review the borrower’s credit policy to ascertain its soundness and credibility.
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| 16.138 | The margin between the amount of the exposure and the value of the receivables must reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual borrower, and potential concentration risk within the bank’s total exposures.
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| 16.139 | The bank must maintain a continuous monitoring process that is appropriate for the specific exposures (either immediate or contingent) attributable to the collateral to be utilized as a risk mitigant. This process may include, as appropriate and relevant, ageing reports, control of trade documents, borrowing base certificates, frequent audits of collateral, confirmation of accounts, control of the proceeds of accounts paid, analyses of dilution (credits given by the borrower to the issuers) and regular financial analysis of both the borrower and the issuers of the receivables, especially in the case when a small number of large-sized receivables are taken as collateral. Observance of the bank’s overall concentration limits should be monitored. Additionally, compliance with loan covenants, environmental restrictions, and other legal requirements should be reviewed on a regular basis
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| 16.140 | The receivables pledged by a borrower should be diversified and not be unduly correlated with the borrower. Where the correlation is high, e.g. where some issuers of the receivables are reliant on the borrower for their viability or the borrower and the issuers belong to a common industry, the attendant risks should be taken into account in the setting of margins for the collateral pool as a whole. Receivables from affiliates of the borrower (including subsidiaries and employees) will not be recognized as risk mitigants.
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| 16.141 | The bank should have a documented process for collecting receivable payments in distressed situations. The requisite facilities for collection should be in place, even when the bank normally looks to the borrower for collections.
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Requirements for recognition of other physical collateral
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| 16.142 | SAMA may allow for recognition of the credit risk mitigating effect of certain other physical collateral when the following conditions are met:
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| | (1) | The bank demonstrates to the satisfaction of SAMA that there are liquid markets for disposal of collateral in an expeditious and economically efficient manner. Banks must carry out a reassessment of this condition both periodically and when information indicates material changes in the market.
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| | (2) | The bank demonstrates to the satisfaction of SAMA that there are well- established, publicly available market prices for the collateral. Banks must also demonstrate that the amount they receive when collateral is realized does not deviate significantly from these market prices.
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| 16.143 | In order for a given bank to receive recognition for additional physical collateral, it must meet all the requirements in paragraphs 16.130 and 16.131, subject to the following modifications:
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| | (1) | With the sole exception of permissible prior claims specified in the footnote to paragraph 16.130, only first liens on, or charges over, collateral are permissible. As such, the bank must have priority over all other lenders to the realized proceeds of the collateral.
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| | (2) | The loan agreement must include detailed descriptions of the collateral and the right to examine and revalue the collateral whenever this is deemed necessary by the lending bank.
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| | (3) | The types of physical collateral accepted by the bank and policies and practices in respect of the appropriate amount of each type of collateral relative to the exposure amount must be clearly documented in internal credit policies and procedures and available for examination and/or audit review.
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| | (4) | Bank credit policies with regard to the transaction structure must address appropriate collateral requirements relative to the exposure amount, the ability to liquidate the collateral readily, the ability to establish objectively a price or market value, the frequency with which the value can readily be obtained (including a professional appraisal or valuation), and the volatility of the value of the collateral. The periodic revaluation process must pay particular attention to “fashion-sensitive” collateral to ensure that valuations are appropriately adjusted downward of fashion, or model-year, obsolescence as well as physical obsolescence or deterioration.
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| | (5) | In cases of inventories (e.g. raw materials, work-in-process, finished goods, dealers’ inventories of autos) and equipment, the periodic revaluation process must include physical inspection of the collateral.
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| 16.144 | General Security Agreements, and other forms of floating charge, can provide the lending bank with a registered claim over a company’s assets. In cases where the registered claim includes both assets that are not eligible as collateral under the foundation IRB and assets that are eligible as collateral under the foundation IRB, the bank may recognize the latter. Recognition is conditional on the claims meeting the operational requirements set out in paragraphs 16.127 to 16.143.
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