CP-1. Guidelines on Regulatory capital under Basel III

Transcription

1 CP-1 Guidelines on Regulatory capital under Basel III

2 Table of Contents Subject Page number Part A- Overview 3 Introduction 3 Applicability 4 Level of application 4 Part B- General requirements 5 Capital adequacy ratios 5 Minimum Capital adequacy requirements 5 Capital buffer requirements 6 Part C- Components of capital 7 Common equity tier 1 (CET1) 7 CET1 of branches of foreign banks 7 Additional Tier 1 capital (AT1) 8 AT1 of branches of foreign banks 8 Tier 2 capital 8 Tier 2 capital of branches of foreign banks 9 Part D- Criteria for inclusion in capital 10 Common/Ordinary shares 10 Additional Tier 1 capital instruments 12 Tier 2 capital instruments 15 Minority interest and capital instruments issued 17 out of consolidated subsidiaries o Common shares 17 o Tier 1 qualifying capital 18 o Tier 1 and Tier 2 qualifying capital 19 Part E- Regulatory adjustments 20 Goodwill & other intangibles 20 Deferred Tax Assets and liabilities 21 Property revaluation gains 21 Cumulative gains/losses on AFS financial 21 instruments Profit equalization reserve/investment risk reserve 21 Page 1 of 41

3 Cash flow hedge reserve 22 Regulatory provisions for loans/financing 22 Shortfall of eligible provisions for expected 22 losses Gain on sale related to securitisation 22 transaction Cumulative gains/losses due to changes in own 22 credit risk on fair valued liabilities Defined benefit pension fund assets and 22 liabilities Investments in own capital instruments and 23 reciprocal cross holdings Investments in the capital of unconsolidated 24 banking, financial/takaful/ insurance entities Changes to risk weighted assets calculation for 28 items formerly deducted from capital Other requirements 28 Minimum capital conservation ratios 28 Requirements to ensure loss absorbency at the 29 point of non-viability Write off or conversion mechanisms for 31 achieving principal loss absorbency at the point of non -viability Disclosure requirements 32 Regulatory process and submission 32 requirements Part F- Transitional arrangements 33 Capital buffer requirements 33 Capital instruments that no longer qualify as 34 non-common equity tier 1 or tier 2 capital Minority interest and capital instruments issued 37 out of subsidiaries, held by third parties and regulatory filters Annex 1: Illustrative example on minority interest 38 and capital instruments issued out of consolidated subsidiaries held by third parties Annex 2: Example of 15% common equity limit on 41 specified items Page 2 of 41

4 Guidelines on regulatory capital under Basel III PART A OVERVIEW 1. Introduction 1.1. Regulatory capital requirements seek to ensure that risk exposures of a bank are backed by an adequate amount of high quality capital which absorbs losses on a going concern basis. This ensures the continuing ability of a bank to meet its obligations as they fall due while also maintaining the confidence of customers, depositors, creditors and other stakeholders in their dealings with the institution. Better definition of Capital requirements, with emphasis on quality, consistency, transparency and scope for support also seeks to further protect depositors and other senior creditors in a gone concern situation by promoting an additional cushion of other permissible non-core capital instruments that can be used to meet claims in the event of liquidation. 1.2 The Basel Committee on Banking Supervision (BCBS) first issued measures to strengthen the Basel II accord in 2009 (popularly known as Basel 2.5) and then issued a regulatory framework for increasing the resilience of banks and the banking system in December 2010, which was revised in June 2011.This framework is called Basel III. The Committee s comprehensive package was a response to the lessons learnt from the economic and financial crisis which began in The Basel III document was reviewed by Central Bank of Oman (CBO) and it was decided to implement the same after due deliberation. The roadmap for its implementation was decided in consultation with all stakeholders. The roadmap had indicated that a concept paper on regulatory capital will be brought out by CBO This document, being the said concept paper, has been prepared based largely on Basel III: A global regulatory framework for more resilient banks and banking systems (Basel III guidelines), Guidelines on Basel II (circular no. BM dated September 13, 2006), the roadmap for implementation of Basel III (circular no. BM-1024 dated August 12, 2012) and the Islamic Banking Regulatory Framework (IBRF) released by CBO (circular no. IB-1 dated December 18, 2012).The draft document was issued for industry consultations in June 2013, and has been finalized after duly considering all the inputs received. BM 1009 will Page 3 of 41

5 provide guidance on aspects not modified here in. Banks should however note to be guided by the Basel III guidelines in approach and spirit, with particular reference to the robustness of Tier 1and Tier 2 additional capital components issued to third parties and should reckon all the dimensions in their ICAAP and related initiatives. 2. Applicability 2.1. The instructions contained herein are applicable to all banks licensed under the Banking Law 2000, including specialized banks and full -fledged Islamic Banks. These institutions are hereafter referred to as bank/banks. 2.2 The terms Central Bank and CBO, wherever used in this document, means the Central Bank of Oman. 3. Level of application 3.1. A bank is required to comply with the capital adequacy requirements based on the instructions contained in BM or Capital Adequacy title of IBRF for Islamic Banks, as applicable, at the following levels: i. The global operations of the bank (i.e. including its overseas branch operations) on a stand-alone basis, and ii. Consolidated level, which includes entities covered under the entity level requirement, and the consolidation of all subsidiaries. Investments in capital of banking, insurance and takaful subsidiaries outside the scope of regulatory consolidation require regulatory adjustments to be made as indicated in paragraph no iii. Local operations of branches of foreign banks operating in the Sultanate of Oman 3.2. Where consolidation of other entities required under paragraph 3.1(ii) is not feasible, banks may seek the CBO s approval for calculating CET 1, providing full details of the case. Separate treatment may be prescribed by CBO for financial and non-financial entities in such a case. 3.3 Multinational banks should follow the more stringent of the home or host country regulations, while complying with the guidelines. Page 4 of 41

6 PART B GENERAL REQUIREMENTS 4. Capital adequacy ratios 4.1. A bank shall calculate its Common Equity Tier 1 (CET1), Tier 1 and Total Capital Ratios in the following manner: i. CET1 Capital Ratio = Common Equity Tier 1 Capital/ Total RWA ii. Tier 1 Capital Ratio= Tier 1 Capital/ Total RWA iii. Total Capital Ratio = Total Capital/ Total RWA 4.2. Tier 1 Capital shall be the sum of CET1 Capital and Additional Tier 1 Capital (AT1) Total Capital shall be the sum of Tier 1 Capital and Tier 2 Capital 4.3. The denominator, viz., Total risk-weighted assets (RWA) shall be calculated as the sum of credit risk weighted assets, market risk-weighted assets, and operational risk-weighted assets, as provided for in BM-1009 and IB-1 or as advised by CBO from time to time. In the case of Islamic banks, the above components shall be further adjusted in the manner stipulated under Article of title 5 of IBRF relating to Capital adequacy, unless otherwise indicated by CBO. 5. Minimum capital adequacy requirements 5.1. Basel III has recommended that the predominant form of capital shall be Tier 1 capital of which CET1 will be the predominant component. Accordingly, based on the presently prescribed level of capital adequacy, banks operating in the Sultanate will be required to maintain at all times, the following minimum capital adequacy ratios: Common equity Capital Ratio: 7% of risk weighted assets Tier 1 Capital Ratio : 9% of risk weighted assets (Going concern capital) Total Capital Ratio : 12% of risk weighted assets (Gone concern capital) Page 5 of 41

7 5.2. Thus, within the minimum Tier I ratio of 9%, Additional CET1 items (please see paragraph no. 8), will be admitted upto a maximum of 2% of Risk Weighted Assets of the bank. Further, within the minimum overall capital of 12%, Tier 2 capital will be admitted upto a maximum of 3% of Risk Weighted Assets of the bank. 6. Capital Buffer requirements 6.1. Additional capital buffers to be held by the banks above the minimum CET1, Tier 1 and Total Capital adequacy levels have also been prescribed. These buffers are intended to encourage the build -up of capital buffers by individual banks during normal times that can be drawn down during stress periods. The Countercyclical Capital Buffer is intended to protect the banking sector as a whole from systemic risk that is often developed during an economic upswing, when there is a tendency towards excessive aggregate credit growth. These buffers, collectively referred to as the Buffer Requirements, comprise of: i. a Capital Conservation Buffer (CCB),which shall be 2.5% of total RWA; and ii. a Countercyclical Capital Buffer (CCyB), which will lie between 0% and 2.5% of total RWA. In case other jurisdictions in which the bank has exposures have levied differing CCyBs, then the CCyB at the consolidated level will have to be maintained as the weighted average of the CCyBs in all the jurisdictions, which shall however, not be less than the CCyB prescribed by CBO. Assuming a zero countercyclical capital buffer, banks shall operate above CET1, Tier 1 and Total Capital levels of 9.5%, 11.5% and 14.5% respectively The capital conservation buffer will be implemented from January 1, 2014 and will take full effect by January 1, The capital buffer requirements applicable before 2017 are set forth in paragraphs on transitional arrangements. It may be noted that banks falling short in maintaining the Capital Conservation Buffer at prescribed levels would need to make good the shortfall at the earliest and would face restrictions on dividend payouts and the like, to promote capital conservation. Note: CBO plans to circulate a concept paper by 2014 providing further guidance on how the Capital Conservation Buffer and Countercyclical Capital Buffer requirements would be operationalised. Page 6 of 41

8 6.3 Notwithstanding what is stated above, the Central Bank may at its discretion, prescribe higher loss absorbency requirements for a bank, based on its risk profile or systemic importance. PART C COMPONENTS OF CAPITAL 7. Common Equity Tier 1 Capital 7.1. Common Equity Tier 1 (CET1) Capital will consist of the following elements: i. common shares issued by the bank that meet the criteria specified in paragraph on common shares; ii. share premium resulting from the issue of common shares; iii. retained earnings net of any interim losses and net of any interim and/or final dividend proposed/declared (It is clarified that, a proposed dividend is to be deducted upon receiving approval of the CBO). iv. other disclosed reserves v. qualifying minority interest (i.e. CET1 capital instruments issued by consolidated subsidiaries of the bank held by third parties.) as determined under paragraph 13 on minority interest vi. Less regulatory adjustments applied in the calculation of CET1 Capital, as determined in Part E. 7.2 Common equity Tier 1 for branches of foreign banks operating in the Sultanate The CET 1 will comprise of the following components:- A) Interest free funds received from HO, maintained in Oman books, for meeting the minimum capital requirements B) Capital deposit funds maintained with CBO C) Non-repatriated surplus retained in Oman books (available on long term basis) D) Less regulatory adjustments/deductions, as applicable to computing of CET1. The net credit balance in inter office head office account, being short term in nature, would not be reckoned towards CET1. The debit balance in Head Office account should also be temporary in nature and reflect non-capital transactions; it should not be utilized inappropriately to move assigned capital out of the country. Page 7 of 41

9 8. Additional Tier 1 Capital 8.1. Additional Tier 1 Capital shall consist of the following: i. Capital instruments issued by the bank that meet the criteria specified in paragraph 11 on additional tier 1 capital, and are not included in CET1 Capital; ii. share premium resulting from the issue of Additional Tier I instruments iii. qualifying Additional Tier 1 capital instruments issued by consolidated subsidiaries of the bank held by third parties, as determined under paragraph 13 on minority interest and which are not included in Common Equity Tier 1; iv. Less regulatory adjustments applied in the calculation of Additional Tier 1 Capital, as indicated in Part E. 8.2 The additional Tier I capital for foreign banks branches operating in Oman would comprise of:- (i) Head office borrowings, complying with regulatory requirements, meant specifically for inclusion in Additional Tier I capital; (ii) Any other item that may be specifically allowed by CBO from time to time Less any regulatory adjustments/deductions (please see Part E). 9. Tier 2 Capital 9.1. Tier 2 Capital shall consist of instruments that meet the following eligibility criteria: i. Capital instruments issued by the bank that fulfill the criteria specified in paragraph 12 on Tier 2 capital instruments, and are not included in Tier 1 Capital; ii. share premium resulting from the issue of Tier 2 instruments iii. qualifying capital instruments issued by consolidated subsidiaries of the bank held by third parties, as determined under paragraph 13 on minority interest, that meet the criteria for inclusion in Tier 2 capital and are not included in Tier 1 capital; iv. loan/financing loss provisions as follows: General Provisions or loan loss reserves held against future, but presently unidentified impairments, and which are available to meet losses materializing subsequently, subject to a maximum of 1.25% of total credit Page 8 of 41

10 risk weighted assets determined under the Standardised Approach for credit risk; v. Revaluation reserves with a haircut of 55% vi. Profit Equalisation & Investment Risk Reserves of Islamic Banks, to the extent permitted in Article of Title 5 of IBRF dealing with Capital adequacy, or as advised by CBO. vii. Less regulatory adjustments applied in the calculation of Tier 2 Capital, as indicated in Part E As mentioned in paragraph 5.2, within the specified overall minimum capital, the Tier 2 capital will be limited to 3% of Risk weighted assets of the banks. In other words, the non-tier 2 capital should be at least 9% of risk weighted assets. Note Share premium that is not eligible for inclusion in CET1 Capital will only be permitted to be included in Additional Tier 1 Capital if the shares giving rise to the stock surplus are permitted to be included in Additional Tier 1 Capital. Likewise, Share premium that is not eligible for inclusion in Tier 1 Capital will only be permitted to be included in Tier 2 Capital if the shares from which the premium has been generated are permitted to be included in Tier 2 Capital. Qualification requirements of instruments for being eligible for inclusion in various tiers of the capital are given in Part D. Tier 2 Capital for Foreign Banks Branches operating in Oman Elements of Tier 2 capital in case of foreign banks branches will be as under: (i) General Provisions and Loss Reserves (as detailed in paragraph (i) above); (ii) Head Office (HO) borrowings received as part of Tier 2 debt capital; (iii) Revaluation reserves at a discount of 55%; Less regulatory adjustments applied in the calculation of Tier 2 Capital, as determined in Part E. Page 9 of 41

11 PART D CRITERIA FOR INCLUSION IN CAPITAL 10. Common/Ordinary shares Ordinary shares can be included in CET1 capital instrument if they meet all the following criteria: i. they represent the most subordinated claim in liquidation of the bank; ii. entitled to a claim on the residual assets that is proportional with its share of issued capital, after all senior claims have been repaid in liquidation (i.e. has an unlimited and variable claim, not a fixed or capped claim); iii. principal is perpetual and never repaid outside of liquidation (Except for repurchases or other means of capital reduction arrangements allowable under relevant law and regulations. Repayment, repurchase or reduction of capital shall also be subject to the prior written approval of CBO). iv. the bank does nothing to create an expectation at issuance that the instrument will be bought back, redeemed or cancelled nor do the statutory contractual terms provide any feature which might give rise to such an expectation; v. distributions are paid out of distributable items (accumulated and realized profits as approved by CBO, so far as they have not been previously distributed or capitalized, less accumulated losses), with the level of distributions not in any way tied or linked to the amount paid up at issuance and is not subject to a contractual cap, except to the extent that the bank is unable to pay distributions that exceed the level of distributable items; vi. there are no circumstances under which distributions are obligatory. Non-payment is therefore not a default event. vii. distributions are paid only after all legal and contractual obligations have been met and payments on more senior capital instruments have been made. This implies that there are no precluding any preferential distributions, including in respect of other elements classified as the highest quality issued capital; Page 10 of 41

12 viii. ordinary shares absorb the first and proportionately greatest share of any losses as they occur (It is clarified that the requirement for a permanent write-off feature in capital instruments as set out Part F, does not negate this criterion being met by ordinary shares) and within the highest quality capital, each instrument absorbs losses on a going concern basis proportionately and pari passu with all the others; ix. the paid-up amount is recognised as equity capital for determining balance sheet insolvency and the paid-up amount is classified as equity under International Financial Reporting Standards and AAOIFI as the case may be; x. they are directly issued and paid-up and the bank has not directly or indirectly funded the purchase of the instrument. If a bank issues shares as payment for the takeover of another entity, those shares also would require prior approval of CBO to be considered as paid up; xi. the paid-up amount is neither secured nor covered by a guarantee of the bank or a related entity (a related entity can include a parent company, a sister company, a subsidiary or an affiliate. A holding company will be treated as a related entity irrespective of whether it forms part of the consolidated banking group.) or subject to any other arrangement that legally or economically enhances the seniority of the claim; xii. ordinary shares are clearly and separately disclosed on the bank s audited balance sheet; xiii. the ordinary shares are only issued with the approval of the shareholders of the bank, either given directly by shareholders or, if permitted by law, given by the board of directors or by other persons duly authorised by the shareholders In case a bank has been allowed to issue different classes of ordinary shares with different levels of voting rights (including non-voting shares), all classes of ordinary shares must be identical in all respects (except the level of voting rights) in order to qualify as a CET1 capital instrument Neither the bank nor a related entity over which it exercises control or significant influence can directly or indirectly purchase and own the common shares nor can the bank directly or indirectly have financed its ownership and purchase, failing which the regulatory adjustments as set out in paragraph on investment in own capital instrument shall apply. Page 11 of 41

13 11. Additional Tier 1 capital instruments Additional Tier 1 capital instruments should meet the following criteria: i. the instrument is issued and paid-up; If a bank issues shares as payment for the takeover of another entity, those shares also would require prior approval of CBO to be considered as paid up ii. the instrument is subordinated to depositors, general creditors and f subordinated debt/sukuk of the bank; iii. the instrument is neither secured nor covered by a guarantee of the bank or a related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis depositors, general creditors and holders of other subordinated debt/sukuk of the bank. It is further clarified that if a bank uses a SPV to issue capital to investors and has provided any support to the SPV (e.g. by contributing a reserve), it will be considered as a breach of this condition; iv. the instrument is perpetual, and therefore does not have a maturity date, step-up features or other incentives for the bank to redeem the instrument.it is clarified that if the instrument is so structured that after the first call date the issuer has to pay withholding taxes, it will be taken as a situation where the issuer s interest payments are increasing (even if the stated interest payment to investors does not change), and will be considered as a step up, thereby breaching this condition; v. the instrument may be callable at the initiative of the bank only after a minimum of five years, subject to the following conditions: a. the exercise of a call option must receive prior written approval of the CBO; b. the bank must not do anything which creates an expectation that the call will be exercised (e.g. calling an instrument and replacing it with a more costly instrument would lead investors to believe that bank will exercise calls on other instruments also), and c. the call option must not be exercised unless: the called instrument is replaced with capital of the same or better quality, and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank (Replacement issues can be concurrent with, but not after the instrument is called); or Page 12 of 41

14 the bank demonstrates to the satisfaction of CBO that its capital position is and can be sustained well above the capital adequacy requirements and capital buffer requirements, as outlined in paragraphs 5 and 6 respectively, even after the call option is exercised; vi. any repayment of principal must be with prior approval of CBO and the bank shall not assume or create market expectations that approval will be given; vii. dividends/coupons must be paid out of distributable items (as indicated in 10.1.(v)), and such distributions are subject to the following conditions: a. the bank should have full discretion at all times to cancel distributions/payments. (Features such as dividend pushers are therefore not allowed. An instrument with a dividend pusher obliges the issuing bank to make a dividend/coupon payment on the instrument if it has made a payment on another (typically more junior) capital instrument or share. Banks cannot also include a condition to convert an Additional Tier 1 instrument into common equity upon non-payment, as it will impede their full discretion to cancel payments.); b. cancellation of discretionary payments must not constitute an event of default; c. the bank must have full access to cancelled payments to meet obligations as they fall due ( the term cancel distributions/payments implies that these payments are extinguished. Making payments/distributions in kind is not permitted); and d. cancellation of distributions/payments must not impose restrictions on the bank except in relation to distributions to ordinary shareholders; Dividend stopper arrangements are not prohibited. However, stoppers must not stand in the way of full discretion of the bank to cancel distributions/payments of the instruments, nor hamper recapitalization of the bank as indicated in criterion xi below; vii. the instrument cannot have a credit sensitive dividend feature, that is a dividend/coupon that is reset periodically based in whole or in part on the credit standing of the bank or any of its affiliated entities; viii. The instrument cannot contribute to liabilities exceeding assets if such a balance sheet test forms part of insolvency law. ix. the provisions governing the instrument classified as liabilities for accounting purposes, must have principal loss absorption through either (i) conversion to common shares at a pre specified trigger point or (ii) a write down Page 13 of 41

15 mechanism which allocates losses to the instrument at a pre specified trigger point. The pre specified trigger point shall not be lower than 7.5% of risk weighted assets. The write down will have the following effects: (i) reduce the claim of the instrument in liquidation; (ii) reduce the amount repaid when a call is exercised and (iii) partially or fully reduce coupon/dividend payments on the instrument. For Islamic banks, write off of sukuk will not be allowed and conversion mechanism will be the only option. It is further clarified that if the underlying Islamic mode on which the sukuk is structured is not amenable to conversion into equity, then the instrument cannot be included as part of additional Tier I capital; x. for Islamic banks, the instrument shall be structured using unrestricted equitybased contracts (e.g. Musharakah, Mudarabah), in addition to meeting other Shariah requirements xi. the instrument cannot have any features that hinder recapitalisation, such as provisions that require the bank to compensate investors if a new instrument is issued at a lower price during a specified time frame; xii. if the instrument is not issued out of a holding company or an operating entity (i.e. an entity set up to conduct business with clients with the intention of earning a profit in its own right, for example a special purpose vehicle), proceeds must be immediately available without limitation to the holding company or operating entity in a form which meets or exceeds all of the other criteria for inclusion in Additional Tier 1 Capital. The capital issued by the SPV should be made available only to one operating agency or holding company of the consolidated group. A bank cannot issue a lower quality capital to a SPV (e.g. Tier 2) and have the SPV issue higher quality capital to third party investors and claim recognition as a higher form of capital. Also, Tier 2 capital issued by the SPV cannot be upstreamed by investing the proceeds in Tier 1 instruments of the operating entity or holding company. In such cases the transactions will be classified as Tier 2 capital at the consolidated group level; Neither the bank nor a related entity over which it exercises control or significant influence can directly or indirectly purchase and own the Additional Tier 1 instrument, nor can the bank directly or indirectly have financed its ownership and purchase, failing which the regulatory adjustments as set out in paragraph on investment in own capital instrument shall apply. Page 14 of 41

16 11.3 Share premium which is not eligible for inclusion in Common Equity Tier 1, will be allowed to be included in Additional Tier 1 capital, only if the shares that give rise to the share premium are permitted to be included in Additional Tier 1 capital. 12. Tier 2 capital instruments The objective of Tier 2 is to provide loss absorption on a gone- concern basis. Based on this objective, an instrument should meet or exceed the minimum set of criteria given below: Tier 2 capital will have instruments that meet all the following criteria: i. the instrument is issued and paid-up; ii. the instrument is subordinated to depositors and general creditors of the bank; iii. the instrument is neither secured nor covered by a guarantee of the bank or a related entity or other arrangement that legally or economically enhances the seniority of the claim vis-à-vis depositors and general creditors of the bank; iv. the instrument has an original maturity of at least five years, and there are no step-up features or other incentives for the bank to redeem the instrument; v. the instrument may be callable at the initiative of the bank only after a minimum of five years, subject to the following conditions: a. the exercise of a call option must receive prior written approval of CBO; b. the bank must not do anything which creates an expectation that the call will be exercised; and c. the call option must not be exercised unless: i. the called instrument is replaced with capital of the same or better quality, and the replacement of this capital is done at conditions which are sustainable for the income capacity of the bank. The replacement issues can be concurrent with but not after the call option on the instrument has been exercised.; ii. the bank demonstrates that its capital position is well above the capital adequacy requirements and capital buffer requirements, as outlined in paragraphs 5 and 6 respectively, after the call option is exercised; (It is clarified that an option to call the instrument after 5 years but prior to the start of the amortization period will not be viewed as an Page 15 of 41

17 incentive to redeem, provided that bank does nothing to create an expectation that the call will be exercised at this point.) vi. the investor must have no rights to accelerate the repayment of future scheduled payments (coupon or principal), except in bankruptcy and liquidation; vii. the instrument cannot have a credit sensitive dividend feature, that is a dividend/coupon that is reset periodically based in whole or in part on the credit standing of the bank or any of its related entities; viii. the instrument should not have been directly or indirectly purchased by the bank or by a related entity over which the bank exercises control or significant influence; the bank should also not have directly or indirectly funded the purchase of the instrument. ix. if the instrument is not issued out of an operating entity or the holding company in the consolidated group (eg a special purpose vehicle), proceeds must be immediately available without limitation to the operating entity or bank in a form which meets or exceeds all of the other criteria for inclusion in Tier 2 Capital; x. for Islamic banks, the instrument shall be structured using exchange contracts that are asset-based (e.g. Ijarah or Murabahah), in addition to meeting other Shariah requirements In the final five years of its contractual maturity, the instrument will be gradually de-recognised from Tier 2 Capital on a straight line basis: Years to maturity (x) Amount recognised in Tier 2 Capital > 5 100% >4 80% >3 60% >2 40% >1 20% 1 0% Neither the bank nor a related party over which it exercises control or significant influence can directly or indirectly purchase and own the Tier 2 instrument, nor can the bank directly or indirectly have financed its ownership and purchase, failing which the regulatory adjustments as set out in paragraph on investment in own capital instrument shall apply Within the overall minimum prescribed capital of 12% (excluding CCB and CCyB),the aggregate amount of Tier 2 instruments cannot exceed 3% of the risk weighted assets, as mentioned in paragraph 5.2.In other words, the Tier 1 capital will be at least 9% of the risk weighted assets. Page 16 of 41

18 12.5 Share premium which is not eligible for inclusion in Tier 1, will be allowed to be included in Tier 2 capital, only if the shares that give rise to the share premium are permitted to be included in Tier 2 capital. 13. Minority interest and other capital instruments issued out of consolidated subsidiaries which are held by third parties 13.1 Under Basel II, minority interest in the consolidated subsidiaries of a bank is recognised in the consolidated capital of the group to the extent it formed part of regulatory capital of those consolidated subsidiaries. But it was felt that while minority interest can support the risks in the subsidiary to which it relates, it may not be available to support risks in the group as a whole. So, under Basel III, the portion of minority interest which supports risks in a subsidiary that is a bank will be included in group s Common Equity Tier 1. A subsidiary is an entity which is controlled (as defined in applicable accounting standards). It may be noted that a bank will comply with the capital adequacy requirements both at consolidated and standalone/solo levels. Accordingly, overseas operations of a bank through its branches will be covered at both the levels and host country requirements will apply, if higher. W h i l e a s s e s s i n g t h e c a p i t a l a d e q u a c y o f a b a n k a l l r e g u l a t o r y a d j u s t m e n t s i n d i c a t e d i n Part E a r e r e q u i r e d t o b e m a d e. Equity and other regulatory capital investments in the capital of banking, insurance/takaful entities outside the scope of regulatory consolidation will be a d j u s t e d f r o m c o n s o l i d a t e d r e g u l a t o r y c a p i t a l o f t h e g r o u p, a s p e r t h e t r e a t m e n t g i v e n in terms of paragraph Common shares issued by the consolidated subsidiaries Minority interest (i.e. a non- controlling interest) arising from the issue of ordinary shares by a fully consolidated subsidiary of the bank may be recognised in common equity CET1 if (i) the ordinary shares giving rise to the minority interest, if issued by the bank itself, meet the criteria for classification as common shares for regulatory purposes and (ii) the subsidiary that issued the instrument, is itself a bank. The issuing institution, to be considered as a bank, should be subject to the same minimum prudential standards and level of supervision as a bank. Page 17 of 41

19 Minority interest in a subsidiary that is a bank will be strictly excluded from the parent bank s common equity if the parent bank or affiliate has entered into any agreements or arrangements to fund directly or indirectly the minority interest in the subsidiary through a SPV or through any other vehicle or arrangement. In other words, i.e. treatment outlined hereafter is for genuine third party common equity contributions to the subsidiary. The amount of minority interest that will be recognised in consolidated common equity shall be calculated as follows: total minority interest meeting the criteria (i) & (ii) minus the amount of surplus common equity Tier 1 of the subsidiary attributable to the minority shareholders. Surplus common equity Tier 1 of the subsidiary (Including associated retained earnings, reserves and after regulatory adjustments) is calculated as common equity tier 1 of the subsidiary minus the lower of :- I. minimum common equity tier 1 requirement of the subsidiary, plus the CCB, (i.e. 9.5% of RWAs), and II. Portion of consolidated minimum common equity tier 1 requirement plus the CCB, relating to the subsidiary. The amount of surplus common equity tier 1 attributable to minority shareholders is calculated by multiplying the Surplus common equity Tier 1 by the percentage of common equity tier 1 held by minority shareholders Tier 1 qualifying capital issued by consolidated subsidiaries Tier 1 capital instruments issued by a fully consolidated subsidiary of the bank and held by third parties (including amounts under paragraph 13.1) may be recognised in consolidated Tier 1 Capital only if the instrument would, if issued by the bank, meets the criteria for inclusion in Tier 1 Capital. The amount of this capital that will be recognised in consolidated Tier 1 Capital is calculated as follows: total tier 1 of the subsidiary issued to third parties minus the amount of surplus Tier 1 of the subsidiary attributable to third party investors. Surplus Tier 1 of the subsidiary is calculated as the tier 1 of the subsidiary minus the lower of :- I. minimum tier 1 requirement of the subsidiary, plus the CCB, (i.e. 11.5% of Risk Weighted Assets), and Page 18 of 41

20 II. Portion of consolidated minimum tier 1 requirement plus the CCB, relating to the subsidiary. The amount of surplus tier 1 attributable to third party investors is calculated by multiplying the Surplus Tier 1 by the percentage of tier 1 held by third party investors. The amount of Tier 1 capital that will be recognized in AT1 will exclude the amounts recognized in CET1, under paragraph Tier 1 and Tier 2 qualifying capital issued by consolidated subsidiaries Total capital instruments issued by a fully consolidated subsidiary of the bank and held by third parties (including amounts under paragraphs 13.1 and 13.2) may be recognised in consolidated Total Capital only if the instruments would, if issued by the bank, meets the criteria for inclusion in l Tier 1 or Tier 2 Capital. The amount of this capital that will be recognised in consolidated Total Capital is calculated as follows: total capital instruments of the subsidiary issued to third parties minus the amount of surplus total capital of the subsidiary attributable to third party investors. Surplus total capital of the subsidiary is calculated as the total capital of the subsidiary minus the lower of :- I. minimum total capital requirement of the subsidiary, plus the CCB, (i.e. 14.5% of Risk Weighted Assets) and II. Portion of consolidated minimum total capital requirement plus the CCB, relating to the subsidiary. The amount of surplus total capital attributable to third party investors is calculated by multiplying the Surplus total capital by the percentage of total capital held by third party investors. The amount of this total capital that will be recognized in Tier 2 will exclude the amounts recognized in CET1, under paragraph 13.2 and AT1, under paragraph no An example illustrating the above treatment is given at Annex Capital issued to third parties out of a special purpose vehicle (SPV) may be included in entity and consolidated level only as Additional Tier 1 or Tier 2 Capital, and treated as if the bank had issued the capital directly to third parties, only if: Page 19 of 41

21 i. the SPV is controlled and managed by the bank, and would, in accordance with IFRS, be fully consolidated; iii. the SPV is set up for the sole purpose of the capital issuance for the bank and does not conduct any other business or activity; iv. the SPV has no external creditors at any time; v. the entire proceeds from the capital issuance through the SPV shall be immediately available without limitation to the bank in a form which meets or exceeds all of the criteria for inclusion in Additional Tier 1 or Tier 2 Capital, as appropriate; vi. the provisions governing the issuance of the instruments issued by the SPV and the bank shall substantially be the same (e.g. maturity), and accordingly, the capital instrument issued by the SPV shall meet all the relevant criteria for inclusion as if the bank itself were to issue the instrument vii. The capital will be included in the bank s consolidated Additional Tier 1 or Tier 2, in accordance with the treatment outlined in paragraphs 13.2 and For example, if an SPV issues a Tier 2 capital instrument to investors and upstreams the proceeds by investing in a Tier 1 capital instrument issued by the bank, the transaction will be recognised in Tier 2 Capital. In the case of capital instruments issued by Islamic banks based on exchange contracts through an SPV (e.g. Murabahah or Ijarah) or using any other indirect structure the contracts between the Islamic bank and the SPV or any parties involved shall be structured in a manner which in combination meets or exceeds the criteria for inclusion in capital. For example, any purchase undertaking shall be designed in a manner that does not legally or economically enhance the seniority of capital issued. PART E REGULATORY ADJUSTMENTS 14.1 Goodwill and other intangibles Goodwill, including any goodwill included in the valuation of significant capital investments in unconsolidated entities, and all other intangibles must be deducted in the calculation of CET1 Capital. The full amount shall be deducted net of any associated deferred tax liability that would be extinguished if the intangible asset becomes impaired or is derecognized. Page 20 of 41

22 It may be clarified that, negative goodwill shall not be added back in the calculation of CET1 Capital Deferred tax assets and liabilities Deferred tax assets (DTAs) that rely on the future profitability of the bank to be realised shall be deducted in the calculation of CET1 Capital. DTA may be netted with its associated deferred tax liability (DTL) only if the DTA and DTL relate to taxes levied by the same taxation authority and offsetting is permitted by the relevant taxation authority. DTLs permitted to be netted against DTAs shall exclude amounts that have been netted against the deduction of goodwill, intangibles and defined benefit pension assets. It may be clarified that net DTLs shall not be added back in the calculation of CET1 Capital Property revaluation gains The amount of cumulative unrealised gains arising from the changes in the fair value or revaluation of bank s own premises is not allowed to be reckoned towards supplementary capital instruments, as provided in paragraph 23 of BM Cumulative gains/losses of financial instruments classified as available-for-sale The latent revaluation reserves or cumulative unrealised gains arising from the changes in fair value of equity instruments, classified as available-for-sale shall be added to Tier 2 with a haircut of 55%, provided this capital could be used to absorb losses on a going concern basis. The amount of cumulative unrealised losses arising from the changes in fair value of financial instruments, including loans/financing and receivables, classified as available-for-sale shall be fully deducted in the calculation of CET1 Capital Profit Equalisation Reserve/Investment Risk Reserve The profit equalisation reserve and investment risk reserve attributable to Islamic banking operations shall be adjusted from the total risk weighted assets in the calculation of Capital adequacy ratio as indicated in article 2.3 of Title 5 of the Islamic Banking Regulatory Framework on Capital Adequacy. As mentioned in article of the title 5 of the Islamic Banking Regulatory Framework on Capital Adequacy, PER and IRR may be included upto a maximum of 30% of the Page 21 of 41

23 risk weighted assets financed by unrestricted investment account holders, in Tier 2 capital, unless otherwise indicated by CBO Cash flow hedge reserve The amount of the cumulative fair value gains on cash flow hedges is to be excluded from the computation of capital. Positive amounts should be deducted and negative amounts added back to CET Regulatory provisions for loans/financing The amount of shortfall in provisioning requirements attributable to loans/financing as required in accordance with the guidelines on Classification and Impairment Provisions outlined in BM 977 and IB-1shall be deducted in the calculation of CET1 Capital Shortfall of eligible provisions for expected losses Where the bank has been allowed to adopt the Internal Ratings-Based approach for credit risk, any shortfall of eligible provisions to expected losses shall be deducted in the calculation of CET1 Capital. The full amount shall be deducted and shall not be reduced by any tax effects that could be expected to occur if provisions were to rise to the level of expected losses Gain on sale related to securitisation transaction Any increase in equity capital resulting from a securitisation transaction, such as that associated with expected future margin income resulting in a gain-on sale, shall be deducted in the calculation of CET1 Capital Cumulative gains/losses due to changes in own credit risk on fair valued liabilities All unrealised fair value gains and losses on financial liabilities that are due to changes in the bank s own credit risk shall be derecognised in the calculation of CET1 Capital Defined benefit pension fund assets and liabilities For each defined benefit pension fund that is a net asset on the balance sheet, the asset shall be deducted in the calculation of CET1 Capital net of any associated deferred tax liability which would be extinguished if the asset becomes impaired or derecognised under International Financial Reporting Standards. The amount of defined benefit pension fund liabilities, as included on the balance sheet, shall be fully recognised in the calculation of CET1 Capital, through a reduction in reserves. Page 22 of 41

24 Assets in the fund to which the bank has unrestricted and unfettered access may, with the prior written approval of the CBO, offset the deduction. Such offsetting assets shall be risk-weighted as if they were owned directly by the bank Investments in own capital instruments and reciprocal cross holdings All direct and indirect holdings of a bank s own capital instruments, whether in the trading book or the banking book, including any own capital instruments which the bank could be contractually obliged to purchase and any other financing provided for the purpose of purchasing own capital instruments, will be deducted in the calculation of capital. In applying the deductions, banks must deduct the investment from the same component of capital for which it would qualify. Thus, banks must deduct investments in own common shares from CET1 (unless already derecognized under relevant accounting standards), investments in their own Additional Tier 1 instruments from the calculation of their Additional Tier 1 capital and must deduct investments in their own Tier 2 instruments in the calculation of their Tier 2 capital. In instances where a bank has an indirect exposure to an own capital instrument (e.g. through an investment in a collective investment scheme or holdings of an index security), the bank should look through the holdings to determine their underlying holdings of capital. If the bank finds it difficult to look through and monitor the exact exposure through their holdings of index securities, they should approach CBO with their conservative estimates to obtain prior approval for their estimation. Banks should demonstrate that in no case, the actual exposure will be higher than the estimate made if specifically/exceptionally approved. Gross long positions may be netted against short positions in the same underlying exposure only if the short positions involve no counterparty risk. In the case of an index security, the bank may net a gross long position against a short position only if it is in the same underlying index. For the purpose of discussion, the short position used to offset the long positions may involve counterparty risk, which will then be subject to the relevant counterparty credit risk charge in accordance with BM 1009 and the Islamic Banking Regulatory Framework. Page 23 of 41

25 As regards reciprocal cross holdings of capital, designed to artificially inflate the banks capital positions, banks will be required to fully deduct such investments in the capital of other banks and regulated entities like FLCs and insurance companies from the same component of capital for which it would have qualified, as if it were issued by the bank itself Investments in the capital of unconsolidated banking, financial/takaful/insurance entities outside the scope of regulatory consolidation U n d e r B a s e l I I I, t h e s e i n v e s t m e n t s h a v e b e e n s u b j e c t e d t o s t r i n g e n t t r e a t m e n t i n t e r m s o f d e d u c t i o n f r o m r e s p e c t i v e t i e r s o f r e g u l a t o r y c a p i t a l, b e c a u s e t h e y c o n t r i b u t e t o i n t e r c o n n e c t e d n e s s. S u c h t r e a t m e n t w i l l h e l p e n s u r e t h a t w h e n c a p i t a l a b s o r b s a l o s s a t o n e f i n a n c i a l i n s t i t u t i o n t h i s d o e s n o t i m m e d i a t e l y r e s u l t i n t h e l o s s o f c a p i t a l i n t h e i n v e s t o r b a n k. I n v e s t m e n t s i n e n t i t i e s t h a t a r e o u t s i d e o f t h e s c o p e o f r e g u l a t o r y c o n s o l i d a t i o n r e f e r t o i n v e s t m e n t s i n e n t i t i e s t h a t h a v e n o t b e e n c o n s o l i d a t e d a t a l l o r h a v e n o t b e e n c o n s o l i d a t e d i n s u c h a w a y a s t o r e s u l t i n t h e i r a s s e t s b e i n g i n c l u d e d i n t h e c a l c u l a t i o n o f c o n s o l i d a t e d r i s k - w e i g h t e d a s s e t s o f t h e g r o u p. T h e t r e a t m e n t u n d e r t w o s c e n a r i o s i s d i s c u s s e d i n t h e f o l l o w i n g p a r a g r a p h s, A & B : - A. Bank does not own more than 10% of the issued common share capital of the entity Investments in the capital instruments of unconsolidated banking, financial and insurance/takaful entities shall include: Page 24 of 41

26 i. direct, indirect and synthetic holdings (e.g. subordinated debt) of capital instruments. Banks shall look through indirect exposures (e.g. through an investment in a collective investment scheme or holdings of an index security) to determine their underlying holdings of capital. Indirect holdings are defined as exposures or part of the exposures that will result in a loss substantially equivalent to the loss in value of the direct holding, if the latter loses value. ii. iii. iv. the net long positions in both the banking book and trading book. Capital includes common shares and other types of cash and synthetic capital instruments. In this regard, the gross long position can be offset against the short position in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year; underwriting positions held for longer than five working days. if the capital instrument of the entity in which the bank has invested in does not meet the criteria for inclusion in Common Equity Tier 1, Additional Tier 1 l, or Tier 2 Capital of the bank, the investment is to be considered as common/ ordinary shares for the purposes of this regulatory adjustment. With the prior written approval of the CBO and subject to conditions that may be specified (including the period of exclusion), certain investments where these have been made in the context of resolving or providing financial assistance to reorganise a distressed institution, can be allowed to be temporarily excluded. If the total of all the holdings as listed above, exceed 10% of the bank s common equity (after applying all the regulatory adjustments given in Part E), then the amount above 10% will be deducted applying the corresponding deduction approach, as follows:- i. aggregate amount in excess of 10% of bank s common equity x common equity holdings/total capital holdings(to be deducted from CET1) ii. aggregate amount in excess of 10% of bank s common equity x Additional Tier I capital holdings/total capital holdings(to be deducted from Additional Tier 1) iii. amount in excess of 10% of bank s common equity x Tier 2 capital holdings/total capital holdings(to be deducted from Tier 2). Page 25 of 41

27 This treatment would ensure that deductions are made in proportion to the proportion of common equity in total capital. Instruments in trading book below the aggregate level of 10% will be risk weighted as per market risk rules and instruments in the banking book will be risk weighted as per standardized approach or the internal ratings based approach, as applicable. For the purpose of risk weighting, the amount of the holdings must be allocated on a pro-rata basis between those below and those above the threshold. B. Significant investments, where bank owns more than 10% of the issued common share capital of the entity which are outside the scope of regulatory consolidation Investments in the capital instruments of banking/financial/takaful/insurance entities, which are outside the scope of regulatory consolidation and where the bank s aggregate investment is exceeding 10% of the issuing entity s common share capital, or where the entity is an affiliate of the bank, will be subject to the regulatory adjustments indicated hereafter. Investments other than common shares shall be fully deducted from the bank s capital following the corresponding deduction method. The corresponding deduction approach implies that the deduction shall be made from the same tier of capital for which the capital would qualify, had it been issued by the bank itself. If the bank does not have enough of that tier of capital, then the shortfall will be deducted from the next higher tier of capital. For the purposes of this section, an affiliate is defined as a company that controls or is controlled by, or is under common control with the bank. Control of a company is defined as (i) ownership, control or holding with power to vote 20% or more of a class of voting shares of the company or (ii) consolidation of the company for financial reporting purposes. The investments as listed below will be reckoned: i. direct, indirect and synthetic holdings of capital instruments. Banks shall look through indirect exposures (e.g. through an investment in a Page 26 of 41

28 iii. iv. ii. collective investment scheme or holdings of an index security) to determine their underlying holdings of capital. the net long positions in both the banking book and trading book. Capital includes common shares and other types of cash and synthetic capital instruments. In this regard, the gross long position can be offset against the short position in the same underlying exposure where the maturity of the short position either matches the maturity of the long position or has a residual maturity of at least one year; underwriting positions held for longer than five working days if the capital instrument of the entity in which the bank has invested in does not meet the criteria for inclusion in Common Equity Tier 1, Additional Tier 1 l, or Tier 2 Capital of the bank, the investment is to be considered as common / ordinary shares for the purposes of this regulatory adjustment It is reiterated that reciprocal cross holdings of capital instruments that are leading to artificially inflate the capital position of a banking institution will have to be fully deducted. Further, any shortfall in the regulatory capital requirements in the un-consolidated entities will also be fully deducted from CET1 of the bank With the prior written approval of the CBO and subject to conditions that may be specified (including the period of exclusion), certain investments where these have been made in the context of resolving or providing financial assistance to reorganise a distressed institution, can be allowed to be temporarily excluded If the investment is issued out of a regulated financial entity and not included in regulatory capital in the relevant sector of the financial entity, it is not required to be deducted. The gross long positions exceeding the threshold, which are deducted from the capital, can be excluded for the calculation of risk weighted assets Investments included above that are common shares will be subject to the threshold treatment as indicated below:- Instead of a full deduction, the following items may each receive limited recognition when calculating Common Equity Tier 1, with recognition capped at 10% of the bank s common equity (after the application of all regulatory adjustments): Page 27 of 41

29 Significant investments in the common shares of unconsolidated financial institutions, viz., banks, insurance and other financial entities, mortgage servicing rights and DTAs arising from temporary differences. In 2013, banks must deduct the amount by which the aggregate of the abovementioned three items exceeds 15% of its common equity component of Tier 1 (calculated prior to the deduction of these items but after application of all other regulatory adjustments applied in calculation of Common Equity Tier 1). The items included in the 15% aggregate limit are subject to full disclosure. As of January 1, 2018, the amount of the abovementioned items that remain recognised after the application of all regulatory adjustments must not exceed 15% of the Common equity Tier 1 capital, calculated after all regulatory adjustments. The amount of the three items that are not deducted in the calculation of Common Equity Tier 1 will be risk weighted at 250%. Please see the example at Annex Changes to the risk-weighted assets calculation for items formerly deducted from capital The following items, deducted equally from Tier 1 & Tier 2 under the Basel II guidelines issued by Basel committee on Banking Supervision, will be subject to a 833% risk weight: (i) securitisation exposures currently subject to deduction, with the exception of any increase in equity capital resulting from a securitisation transaction which will continue to be deducted; (ii) certain equity exposures under the PD/LGD approach determined under the Internal Ratings-Based approach; (iii) non-payment/delivery on non-dvp and non-pvp transactions; and (iv) significant investments in commercial entities. OTHER REQUIREMENTS 15.1 Minimum capital conservation ratios The table below shows the minimum capital conservation ratios a bank must meet at various levels of the Common Equity Tier 1 (CET1) capital ratios. For example, Page 28 of 41

30 a bank with a CET1 capital ratio in the range of 7.625%-8.25% is required to conserve 80% of its earnings (i.e. payout no more than 20% in terms of dividends, share buybacks and discretionary bonus payments). If the bank wants to make payments in excess of the constraints imposed by this regime, it would have the option of raising capital equal to the amount above the constraint which it wishes to distribute. This would be discussed with CBO as part of the capital planning process. The Common Equity Tier 1 ratio includes amounts used to meet the 7% minimum Common Equity Tier 1 requirement, but excludes any additional Common Equity Tier 1 needed to meet the 9% Tier 1 and 12% Total Capital requirements. For example, a bank with 12% CET, and no Additional Tier 1 or Tier 2 capital would meet all minimum capital requirements, but would have a zero conservation buffer and therefore be subject to the 100% constraint on capital distributions. Individual bank minimum capital conservation standards Common Equity Tier 1 Ratio Minimum Capital Conservation ratio * 7% % 100% >7.625% % 80% >8.25% % 60% >8.875% - 9.5% 40% > 9.5% 0% *expressed as a percentage of earnings 15.2 Once the countercyclical buffer is also in force, it will be implemented through an extension of the capital conservation buffer. Assuming the banks are subjected to CCyB of 2.5%, the bank s minimum capital conservation standards will be as under:- Individual bank minimum capital conservation standards, when a bank is subject to a 2.5% countercyclical requirement Common Equity Tier 1 Ratio Minimum Capital (including other fully Conservation loss absorbing capital ) ratio * 7% % 100% >8.25% - 9.5% 80% >9.5% % 60% >10.75% - 12% 40% > 12% 0% *expressed as a percentage of earnings Page 29 of 41

31 The dividend payouts will however continue to be subject to CBO s discretion and approval Requirements to ensure loss absorbency at the point of non-viability The provisions governing the issuance of all non-common equity tier 1 and Tier 2 capital instrument shall contain clauses that require such instruments, at the option of CBO, to be written-off, or the instrument to be converted into ordinary shares, upon the occurrence of a trigger event, which shall be the earlier of the following: i. A notification, to the bank in writing that CBO is of the opinion that a write-off or conversion is necessary without which the firm will become non-viable; or ii. A decision is taken to make a public sector injection of capital, or equivalent support, without which the firm would have become non-viable. The write-off or issuance of any new shares as a result of conversion or consequent upon the trigger event must occur prior to any public sector injection of capital. The AT1 instruments with write-off clause will be permanently written-off when there is public sector injection of funds. Any compensation paid to the instrument holders as a result of the write-off must be paid immediately in the form of common stock (or its equivalent in the case of non-joint stock companies). The issuing bank must maintain at all times all prior authorisation necessary to immediately issue the relevant number of shares specified in the instrument s terms and conditions, should the trigger event occur. Therefore, the contractual terms need to work within the confines of what is permissible under national company law and the bank s articles of association The write down /conversion should generate CET1 under the relevant accounting standards. It will receive recognition in Additional CET1, only upto the minimum extent upto which it would generate the CET1 after conversion. The aggregate amount to be written-down /converted for all such instruments must be at least equal to the amount needed to immediately return the bank s CET1 ratio to the trigger level, and if that is not possible then the write off/conversion should be for the full principal value of the instrument. Page 30 of 41

32 15.5 For purposes of recognising capital at the consolidated level, the provisions governing the issuance of an Additional Tier 1 or Tier 2 capital instrument issued by a subsidiary (apart from a banking subsidiary regulated by the Bank) and held by third party investors shall also contain clauses that require the instrument, at the option of the Central Bank, to be written-off, or the instrument to be converted into ordinary shares upon the occurrence of the trigger event. 16. Write-off or conversion mechanisms for achieving principal loss absorption and/or loss absorbency at the point of non-viability In respect of the requirement for a capital instrument that can be written-off: i. the write-off shall fully reduce: a. the claim of the instrument in liquidation; b. the amount to be re-paid when a call option is exercised; and c. coupon or dividend payments on the instrument; ii. the write-off shall be permanent ; and iii. the provisions governing the issuance of the instrument must specify that a write-off shall not constitute an event of default for that capital instrument or trigger cross-default clauses In respect of the requirement for a capital instrument that can be converted into ordinary shares: i. the bank must maintain at all times all prior authorization necessary to immediately issue the relevant number of shares specified in the provisions governing the issuance of the instrument should the trigger event occur; ii. the conversion formula for determining the number of ordinary shares received upon conversion of the instrument must be determined in advance in the provisions governing the issuance of the instrument and comply with legal and regulatory limitations, including limitation on shareholding in banks; iii. the issuance of any new shares as a result of the trigger event must occur prior to any public sector injection of capital (or equivalent support); iv. Any ordinary shares arising from the conversion may be the ordinary shares of either the issuing bank, parent company or any other affiliated entity, including any successor in resolution; and Page 31 of 41

33 v. the provisions governing the issuance of the instrument must specify that a conversion shall not constitute an event of default for that instrument or trigger cross-default clauses For Islamic banks, only conversion into ordinary shares is allowed, i.e. no write offs are permissible It is reiterated that the banks should ensure that the relative offer documents clearly emphasise the possibility of curtailment of the rights of the holders of the instrument at the point of non-viability as detailed above, which will override any other provisions/regulations that may be contained elsewhere. Further it is also reiterated that prior authorisations for conversion/write-off, CMA s clearance etc. should be in place and restriction of bond holders rights etc. should be unambiguously mentioned in the offer documents. 17. Disclosure requirements Banks are required to make available on their websites the full terms and conditions of all instruments included in regulatory capital. Banks are also required to make enhanced disclosures on capital as indicated by Basel Committee on Banking Supervision, beginning from the financial year ending on December 31, 2013, and with every published financial statements thereafter, whether audited or not. Separate guidelines on disclosure of capital components have been issued in an accompanying document (CP-2). As indicated therein, the relevant disclosure statements (templates) will be forwarded to Banking Surveillance Department on a quarterly basis. 18. Regulatory process and submission requirements A bank is required to obtain the CBO s written approval prior for issuance of regulatory capital in Additional Tier 1 Capital or Tier 2 Capital by the bank, or issuance to third parties out of a special purpose vehicle. An application must be accompanied by the following documents/details: i. a confirmation of compliance by the Chief Executive Officer that the proposed capital instruments comply with all the criteria for inclusion in capital. In addition the CBO may require the bank to provide an external legal opinion from a reputed firm and at the bank s expense, confirming that the instrument complies with all relevant criteria for inclusion in capital. Page 32 of 41

34 ii. indicative (or where available, final) offering documents; iii. for the purpose of ensuring compliance with the requirements an external legal opinion: a. confirming that write-off or conversion into common equity at the relevant trigger point is enforceable under the bank s articles of association, and relevant company and/or CMA laws; b. confirming that write-off or conversion into common equity at the relevant trigger point does not constitute an event of default for that instrument or trigger cross-default clauses; and c. highlighting other potential impediments to the write-off or conversion of the instrument into common/ordinary shares upon a trigger event and how they have been resolved. Notwithstanding what is stated above, CBO, at its discretion may call for further details/documents to clarify matters A bank is required to obtain the CBO s written approval prior for making any planned reduction in its capital, including capital instruments issued out of consolidated subsidiaries held by third parties. The bank is required to demonstrate, through its capital plans, that the planned reduction of capital results in capital levels remaining well above the minimum capital adequacy and capital buffer requirements, and consistent with its risk profile and business plans Applications in this regard shall be sent to: Senior Manager Banking Development Department Central Bank of Oman 18.4 Banks may note that herein or elsewhere, provisions relating to SPV, subsidiaries, holding companies etc., though provided for, need to conform to basic enabling legal and regulatory provisions as and when they accrue Issues possibly arising due to merger, consolidation etc., particularly relating to Tier 1 and Tier 2 instruments and triggering effects, shall be separately addressed as and when needed. Part F TRANSITIONAL ARRANGEMENTS Page 33 of 41

35 19.1 The capital conservation buffers shall be phased in as follows:- January 1 Capital Conservation Buffer Before % % % % % The countercyclical capital buffer, applicable if any before 2017 shall be subject to the following scaling factors, following the pattern of phasing in of the capital conservation buffer as indicated in paragraph 19.2: January 1 Counter cyclical Capital Buffer Before % % % % % 20 Capital instruments that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital 20.1 The following paragraphs describe the transition arrangements for instruments recognised as capital under the existing framework prior to 1 January Instruments issued in excess of the limits allowed for recognition prior to 1 January 2013 (e.g. Tier 2 Capital exceeding the limit of 100% of Tier 1 Capital) will not be eligible for the gradual phasing-out treatment. Other such instruments will continue to be recognized post 2013 subject to a gradual phase out by December 31, 2022, unless if they meet all the criteria for inclusion set out in paragraphs 13 and 14, and have received the written approval of the CBO. The phase out treatment has been described in the following paragraphs. Page 34 of 41

36 20.2 Additional Tier 1 and Tier 2 capital instruments issued prior to August 12, 2012 which do not have any incentives to redeem: (i) will be fully recognized if they meet all the criteria including point of non viability criteria; (ii) will be subject to gradual phase out if they do not meet all the relevant criteria for inclusion 20.3 Additional Tier 1 and Tier 2 capital instruments issued on, or before, August 12, 2012 (i.e. date of issue of roadmap for implementation of Basel III) that have call features and incentives to be redeemed, are subject to the following transitional arrangements: i. a capital instrument with an effective maturity date on, or before, August 12, 2012 that remains not called after its effective maturity date: a. will continue to be fully recognised if it meets all the relevant criteria for inclusion on a forward looking basis; or b. will be subject to the gradual phase-out treatment if it does not meet all the relevant criteria for inclusion on a forward looking basis. ii. a capital instrument with an effective maturity date between, and including, August 13, 2012 and 31 December 2012 that remains not called after its effective maturity date: a. will continue to be fully recognised if it meets all the relevant criteria for inclusion on a forward looking basis; b. will be subject to the gradual phase-out treatment if it meets all the relevant criteria for inclusion on a forward looking basis, with the exception of the condition relating to point of non viability; c. will be immediately derecognised if it does not meet all other relevant criteria for inclusion, on a forward looking basis. iii. a capital instrument with an effective maturity date on, or after, 1 January 2013 that remains not called after its effective maturity date will be subject to the gradual phase-out treatment from January 2013, and after its call date: a. will be fully recognised only if it meets all the relevant criteria for inclusion on a forward looking basis; and b. will be fully derecognised if it does not meet all the relevant criteria for inclusion on a forward looking basis. x. If the call option is exercised, it will be subject to gradual phase out from January 1, 2013 till it gets extinguished on exercise of the call. Page 35 of 41

37 20.4 Additional Tier 1 and Tier 2 capital instruments issued between, and including, August 13, 2012 and December 31,2012 shall be subject to the following transitional arrangements: i. a capital instrument meeting all the relevant criteria for inclusion will continue to be fully recognised; ii. a capital instrument meeting all the relevant criteria for inclusion (with the exception of the condition relating to point of non-viability), will be subject to the gradual phase-out treatment; and iii. a capital instrument not meeting all other relevant criteria for inclusion, will be fully derecognised. 21. The gradual phase-out treatment will allow for a limited recognition of certain capital instruments previously recognised but no longer meeting the criteria for inclusion as non-common equity Tier 1 or Tier 2 capital, eventually resulting in such instruments being fully derecognised by December 31, The treatment for the limited recognition is as follows: i. Determine the base for the phase-out treatment, which shall be the total amounts of Additional Tier 1 and Tier 2 instruments outstanding as on January 1, 2013 eligible for the gradual phase-out treatment, counted separately. Share premium on instruments that do not meet the criteria for entry but are eligible for the transitional arrangements, should be included in the base. The base amount should also reflect the outstanding amount that is eligible (including caps and ceilings under BM 1009) for inclusion in the relevant tier of capital as on December 31, 2012; ii. The amount of capital instruments eligible for the gradual phase-out treatment that can be recognised shall be capped at 90% of the base in 2013 (counted separately for Additional Tier 1 and Tier 2 Capital), with the cap reducing by 10% in each subsequent year; till it reaches 0% by end of iii. To the extent an instrument is redeemed, or its recognition in capital is amortised after January 1, 2013, the nominal amount serving as the base is not reduced. 22. It is clarified that CET1 capital instruments, regardless of issuance date, and Additional Tier 1 and Tier 2 capital instruments issued after 1 January 2013 do not qualify for any of the transition arrangements described above. Page 36 of 41

38 23. A bank must, prior to November 30, 2013, notify the CBO of the following: i. for instruments subject to the gradual phase-out treatment, the name of the issue, nominal amount and first available call date, as well as a calculation of the base amounts as on 1 January 2013 and ii. for instruments which meet all the relevant criteria for inclusion on a forward looking basis (including ordinary shares), a confirmation of compliance by the Chief Executive Officer. The compliance shall be forwarded to: Senior Manager Banking Surveillance Department Central Bank of Oman and a copy of the same will be sent to Senior Manager, Banking Development Department, Central Bank of Oman. 24 Minority interest and capital instruments issued out of subsidiaries and held by third parties and regulatory filters Regulatory adjustments of all deductions and prudential filters would be phased in and deducted from CET1/AT1/T2 so as to be completely implemented by December 31, 2017.The gradual phase in is given in the following table:- Year ending Deduction using the corresponding deduction approach % % % % % Any shortfall in mandated deductions shall be deducted from the next higher tier of capital if the relevant tier of capital is insufficient for the deduction. The remainder amount not deducted from CET1/AT1/T2 during the transitional arrangement will be subject to the regulatory adjustments as provided in BM ******************************* Page 37 of 41

39 Annex 1 Illustrative example on minority interest and capital instruments issued out of consolidated subsidiaries held by third parties (Reference: Paragraphs of this document) A banking group consists of two legal entities that are both banking institutions. Bank P is the parent and Bank S is the subsidiary and their unconsolidated balance sheets are set out below: Bank P balance sheet Bank S balance sheet Assets Assets Loans to customers 100 Loans to customers 150 Investment in CET1 of Bank S 7 Investment in the AT1 of Bank S 4 Investment in the T2 of Bank S 2 Total 113 Total: 150 Liabilities and equity Liabilities and equity Depositors 70 Depositors 127 Tier 2 10 Tier 2 8 Additional Tier 1 7 Additional Tier 1 5 Common equity 26 Common equity 10 Total 113 Total: 150 The balance sheet of Bank P shows that in addition to its loans to customers, it owns 70% of the ordinary shares of Bank S, 80% of the Additional Tier 1 Capital of Bank S and 25% of the Tier 2 Capital of Bank S. The ownership of the capital of Bank S is therefore as follows: Description Capital issued by Bank S Amount issued to Parent (Bank P) Amount issued to third parties Total Common Equity Tier 1 (CET1) Additional Tier 1 (AT1) Tier 1 (T1) Tier 2 (T2) Total (TC) Page 38 of 41

40 The consolidated balance sheet of the banking group is set out below:- Consolidated balance sheet Assets Loans to customers 250 Liabilities and equity Deposits 197 Tier 2 issued by subsidiary to 3rd parties 6 Tier 2 issued by parent 10 Additional Tier 1 issued by subsidiary to 3rd parties 1 Additional Tier 1 issued by parent 7 Common equity issued by subsidiary to 3rd parties 3 Common equity issued by parent 26 Total liabilities & equity 250 For illustrative purposes Bank S is assumed to have risk weighted assets of 100. In this example, the minimum capital requirements of Bank S and the subsidiary s contribution to the consolidated requirements are the same since Bank S does not have any loans to Bank P. This means that it is subject to the following minimum plus capital conservation buffer requirements and has the following surplus capital: Minimum and surplus capital of bank S Minimum plus CCB Surplus Common equity Tier 1 (CET1) Tier 1 (T1) Total Capital (TC) The following table illustrates the calculation of the amount of capital issued by Bank S to include in the consolidated capital, as indicated in paragraph 13. Page 39 of 41

41 Bank S: amount of capital issued to third parties included in consolidated capital Surplus attributable to Amount Amount 3rd parties, i.e. included issued to Surplus amount excluded in third parties from consolida consolidated capital ted capital (a) (b) (c) (d)=c*b/a (e) =b-d Total amount issued Common equity Tier 1 (CET1) Tier 1 (T1) Total Capital A summary of the components of capital for the consolidated group, based on the amounts calculated above, is given below. The Additional Tier 1 is calculated as the difference between CET1 and T1, and Tier 2 is the difference between Tier 1 and Total capital. Summary position of the consolidated group Amount issued by subsidiaries to third parties to be included in consolidated capital Description Total amount issued by parent, all of which is to be included in consolidated capital Total amount issued by parent and subsidiary to be included in consolidated capital CET AT T T TC Page 40 of 41

42 The 15% of common equity limit on specified items Annex 2 1. This annex is meant to clarify the calculation of the 15% limit on significant investments in the common shares of unconsolidated financial institutions (banks, insurance, takaful, and other financial entities); mortgage servicing rights, and deferred tax assets arising from temporary differences (collectively referred to as specified items please refer to paragraph no of this document.) 2. The recognition of these specified items will be limited to 15% of Common Equity Tier 1 (CET1) capital, after the application of all deductions. To determine the maximum amount of the specified items that can be recognised*, banks and supervisors should multiply the amount of CET1** (after all deductions, including after the deduction of the specified items in full) by 17.65%. This number is derived from the proportion of 15% to 85% (i. e. 15%/85% = 17.65%). 3. As an example, take a bank with RO 85 million of common equity (calculated net of all deductions, including after the deduction of the specified items in full). 4. The maximum amount of specified items that can be recognised by this bank in its calculation of CET1 capital is RO 85 million 17.65% = RO 15 million. Any excess above RO 15 million must be deducted from CET1. If the bank has specified items (excluding amounts deducted after applying the individual 10% limits) that in aggregate sum up to the 15% limit, CET1 after inclusion of the specified items, will amount to RO 85 million + RO 15 million= RO 100 million. The percentage of specified items to total CET1 would equal 15%. * The actual amount that will be recognised may be lower than this maximum, either because the sum of the three specified items are below the 15% limit set out in this annex, or due to the application of the 10% limit applied to each item. ** At this point this is a ʺhypotheticalʺ amount of CET1, in that it is used only for the purposes of determining the deduction of the specified items. Page 41 of 41