Minimum Capital Requirements for Credit Risk

Equity exposures are defined on the basis of the economic substance of the instrument. They include both direct and indirect ownership interests, 12 whether voting or non-voting, in the assets and income of a commercial enterprise or of a financial institution that is not consolidated or deducted. An instrument is considered to be an equity exposure if it meets all of the following requirements: 1. It is irredeemable in the sense that the return of invested funds can be achieved only by the sale of the investment or sale of the rights to the investment or by the liquidation of the issuer; 2. It does not embody an obligation on the part of the issuer; and 3. It conveys a residual claim on the assets or income of the issuer. 7.48 In addition to instruments classified as equity as a result of paragraph 7.47, the following instruments must be categorized as an equity exposure: 1. An instrument with the same structure as those permitted as Tier 1 capital for banking organizations. 2. An instrument that embodies an obligation on the part of the issuer and meets any of the following conditions: (a) The issuer may defer indefinitely the settlement of the obligation; (b) The obligation requires (or permits at the issuer’s discretion) settlement by issuance of a fixed number of the issuer’s equity shares; (c) The obligation requires (or permits at the issuer’s discretion) settlement by issuance of a variable number of the issuer’s equity shares and (ceteris paribus) any change in the value of the obligation is attributable to, comparable to, and in the same direction as, the change in the value of a fixed number of the issuer’s equity shares 13 ; or, (d) The holder has the option to require that the obligation be settled in equity shares, unless either (i) in the case of a traded instrument, SAMA is content that the bank has demonstrated that the instrument trades more like the debt of the issuer than like its equity, or (ii) in the case of non-traded instruments, SAMA is content that the bank has demonstrated that the instrument should be treated as a debt position. In cases (i) and (ii), the bank may decompose the risks for regulatory purposes, with the approval of SAMA. 7.49 Debt obligations and other securities, partnerships, derivatives or other vehicles structured with the intent of conveying the economic substance of equity ownership are considered an equity holding 14 . This includes liabilities from which the return is linked to that of equities 15 . Conversely, equity investments that are structured with the intent of conveying the economic substance of debt holdings or securitization exposures would not be considered an equity holding. 16 7.50 Banks will assign a risk weight of 400% to speculative unlisted equity exposures described in paragraph 7.51 and a risk weight of 250% to all other equity holdings. 7.51 Speculative unlisted equity exposures are defined as equity investments in unlisted companies that are invested for short-term resale purposes or are considered venture capital or similar investments, which are subject to price volatility and are acquired in anticipation of significant future capital gains 17 . 7.52 Banks will assign a risk weight of 150% to subordinated debt and capital instruments other than equities. 7.53 Notwithstanding the risk weights specified in paragraphs 7.50 to 7.52, the risk weight for investments in significant minority- or majority-owned and – controlled commercial entities depends upon the application of two materiality thresholds: 1. For individual investments, 15% of the bank’s capital; and 2. For the aggregate of such investments, 60% of the bank’s capital.