Minimum Capital Requirements for Credit Risk

The overarching principle behind these requirements is that rating and risk estimation systems and processes provide for a meaningful assessment of borrower and transaction characteristics; a meaningful differentiation of risk; and reasonably accurate and consistent quantitative estimates of risk. Furthermore, the systems and processes must be consistent with internal use of these estimates. 16.5 The minimum requirements set out in this chapter apply to all asset classes unless noted otherwise. The standards related to the process of assigning exposures to borrower or facility grades (and the related oversight, validation, etc.) apply equally to the process of assigning retail exposures to pools of homogenous exposures, unless noted otherwise. 16.6 The minimum requirements set out in this chapter apply to both foundation and advanced approaches unless noted otherwise. Generally, all IRB banks must produce their own estimates of probability of default (PD 63 ) and must adhere to the overall requirements for rating system design, operations, controls, and corporate governance, as well as the requisite requirements for estimation and validation of PD measures. Banks wishing to use their own estimates of LGD and EAD must also meet the incremental minimum requirements for these risk factors included in paragraphs 16.82 to 16.110 . 63 Banks are not required to produce their own estimates of PD for exposures subject to the supervisory slotting approach Section 2: Compliance with Minimum Requirements 16.7 To be eligible for an IRB approach, a bank must demonstrate to SAMA that it meets the IRB requirements in this framework, at the outset and on an ongoing basis. Banks’ overall credit risk management practices must also be consistent with the evolving sound practice/guidelines issued by SAMA. 16.8 There may be circumstances when a bank is not in complete compliance with all the minimum requirements. Where this is the case, the bank must produce a plan for a timely return to compliance, and seek approval from its supervisor, or the bank must demonstrate that the effect of such noncompliance is immaterial in terms of the risk posed to the institution. Failure to produce an acceptable plan or satisfactorily implement the plan or to demonstrate immateriality will lead SAMA to reconsider the bank’s eligibility for the IRB approach. Furthermore, for the duration of any noncompliance, SAMA will consider the need for the bank to hold additional capital under the supervisory review process or take other appropriate supervisory action. Section 3: Rating System Design 16.9 The term “rating system” comprises all of the methods, processes, controls, and data collection and IT systems that support the assessment of credit risk, the assignment of internal risk ratings, and the quantification of default and loss estimates. 16.10 Within each asset class, a bank may utilize multiple rating methodologies /systems. For example, a bank may have customized rating systems for specific industries or market segments (e.g. middle market, and large corporate). If a bank chooses to use multiple systems, the rationale for assigning a borrower to a rating system must be documented and applied in a manner that best reflects the level of risk of the borrower. Banks must not allocate borrowers across rating systems inappropriately to minimize regulatory capital requirements (i.e. cherry- picking by choice of rating system). Banks must demonstrate that each system used for IRB purposes is in compliance with the minimum requirements at the outset and on an ongoing basis. Rating dimensions: standards for corporate, sovereign and bank exposures 16.11 A qualifying IRB rating system must have two separate and distinct dimensions: (1) the risk of borrower default; and (2) transaction-specific factors.