Minimum Capital Requirements for Credit Risk

SAMA may deny the use of the top-down approach for purchased corporate receivables depending on the bank’s compliance with minimum requirements. In particular, to be eligible for the proposed ‘top-down’ treatment, purchased corporate receivables must satisfy the following conditions: (1) The receivables are purchased from unrelated, third party sellers, and as such the bank has not originated the receivables either directly or indirectly. (2) The receivables must be generated on an arm’s-length basis between the seller and the obligor. (As such, intercompany accounts receivable and receivables subject to contra-accounts between firms that buy and sell to each other are ineligible. 52 ) (3) The purchasing bank has a claim on all proceeds from the pool of receivables or a pro-rata interest in the proceeds. 53 (4) SAMA may establish concentration limits above which capital charges must be calculated using the minimum requirements for the bottom-up approach for corporate exposures. 10.29 The existence of full or partial recourse to the seller does not automatically disqualify a bank from adopting this top-down approach, as long as the cash flows from the purchased corporate receivables are the primary protection against default risk as determined by the rules in paragraphs 14.4 to 14.7 for purchased receivables and the bank meets the eligibility criteria and operational requirements. 52 Contra-accounts involve a customer buying from and selling to the same firm. The risk is that debts may be settled through payments in kind rather than cash. Invoices between the companies may be offset against each other instead of being paid. This practice can defeat a security interest when challenged in court. 53 Claims on tranches of the proceeds (first loss position, second loss position, etc.) would fall under the securitization treatment. Foundation and Advanced Approaches 10.30 For each of the asset classes covered under the IRB framework, there are three key elements: (1) Risk components: estimates of risk parameters provided by banks, some of which are supervisory estimates. (2) Risk-weight functions: the means by which risk components are transformed into risk-weighted assets and therefore capital requirements. (3) Minimum requirements: the minimum standards that must be met in order for a bank to use the IRB approach for a given asset class. 10.31 For certain asset classes, there are two broad approaches: a foundation and an advanced approach. Under the foundation approach (F-IRB approach), as a general rule, banks provide their own estimates of PD and rely on supervisory estimates for other risk components. Under the advanced approach (A-IRB approach), banks provide their own estimates of PD, LGD and EAD, and their own calculation of M, subject to meeting minimum standards. For both the foundation and advanced approaches, banks must always use the risk-weight functions provided in this Framework for the purpose of deriving capital requirements. The full suite of approaches is described below. 10.32 For exposures to equities, as defined in paragraph 10.24 , the IRB approaches are not permitted (see paragraph 10.41 ). In addition, the A-IRB approach cannot be used for the following: (1) Exposures to general corporates (i.e. exposures to corporates that are not classified as specialized lending) belonging to a group with total consolidated annual revenues greater than SAR 2,230m. (2) Exposures in the bank asset class in paragraph 10.17 , and other securities firms and financial institutions (including insurance companies and any other financial institutions in the corporate asset class).