Large Exposure (LEX) Rules for Banks

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In the name of Allah, the Most Gracious, the Most Merciful. Saudi Arabian Monetary Authority (SAMA) Head Office Banking Policy Department Ref No: Enclosures: 41 pages

Ref No: 1651/67 Date: 1441/01/09 (Hijri) Enclosures: 41 pages

Circular

To: The Respected, Peace, mercy and blessings of Allah be upon you,

Subject: Update of Large Exposure Rules.

With reference to the Large Exposure Rules issued under SAMA Circular No. 361000067330 dated 1436/5/7H, and subsequent updates issued under SAMA Circular No. 391000059150 dated 1439/5/22H and Circular No. 4520/1/41 dated 1439/10/14H.

We inform you of the updated Large Exposure Rules for banks to align with international best practices. The updated enclosures are attached, and the Authority emphasizes that all banks must comply with them.

For information and action as of October 1, 2019. Yours sincerely,

Fahd bin Ibrahim Al-Shathri Deputy Governor for Supervision

Distribution Scope:

• Banks and financial institutions operating in the Kingdom

Al-Thaniyan, P.O. Box 2992, Riyadh 11169, Telegram: MARKAZI, Telex: 404400, Tel: 4633000, Fax: 4662414

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Saudi Arabian Monetary Authority (SAMA) Large Exposure (LEX) Rules for Banks August 2019

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Contents

1. General Requirements ................................................................................................................................. 3 1.1. Introduction ............................................................................................................................................. 3 1.2. Objectives of the Rules ........................................................................................................................... 3 1.3. Definitions ............................................................................................................................................... 4
2. Scope and Level of Application ................................................................................................................. 8 2.1. Level of Application ............................................................................................................................... 8 2.2. Scope of counterparties ........................................................................................................................... 8
3. Governance and Risk Management ............................................................................................................ 9
4. Maximum Exposure Limits ........................................................................................................................ 9 4.1. Exposure Limits ...................................................................................................................................... 9 4.2. Measurement of Exposures and Capital Base ....................................................................................... 11 4.3. Breaches of Limits ................................................................................................................................ 11
5. Measurement of Exposures Values .......................................................................................................... 11 5.1. General Measurement Principles ............................................................................................................ 11 5.2. Eligible credit risk mitigation (CRM) techniques ................................................................................. 12 5.3. Recognition of CRM techniques in reduction of original exposure ....................................................... 14 5.4. Recognition of exposures to CRM providers ......................................................................................... 14 5.5. Treatment of Specific Measurement Issues ........................................................................................... 15 5.6. Exposures Exempted from Exposure Limits ......................................................................................... 16
6. Additional Requirements .......................................................................................................................... 17
7. Regulatory Reporting ............................................................................................................................... 17
8. Implementation ......................................................................................................................................... 18
9. Effective Date .......................................................................................................................................... 18

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Large Exposure (LEX) Rules for Banks

1. General Requirements: 1.1. Introduction:

These Rules are issued by Saudi Arabian Monetary Authority (SAMA) in exercise of the powers vested upon it under its Charter issued by the Royal Decree No.23 on 23-05-1377H (15 December 1957G) and the Banking Control Law issued by the Royal Decree No. M/5 on 22-02-1386H (11 June 1966G) and the rules for Enforcing its Provisions issued by Ministerial Decision No 3/2149 on 14/10/1406AH.

These Rules set out the minimum requirements on large exposures including the limits on a bank’s exposures to a single counterparty, and groups of connected counterparties as well as the types of exposures to be included in or excluded from those limits, and the regulatory reporting requirements for large and connected exposures.

These Rules shall supersede the existing SAMA rules on Large Exposures of Banks issued vide SAMA circular no. 4520/1/41 dated 14/10/1439AH. The changes from the previous version are underlined.

1.2. Objectives of the Rules: The main objectives of these Rules are to enable banks: i. To contain the maximum loss a bank could face in the event of a sudden default or failure of a counterparty; ii. To manage credit concentration risk emanating from concentrated exposures to single counterparties or groups of connected counterparties, through diversification of credit portfolio; iii. To put in place a large exposures framework which complements and serves as a backstop to the risk-based capital requirements; iv. To deal effectively with large exposures so as to contribute to the stability of the financial system; and v. To ensure broader access to credit for the economic development of the Kingdom.

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1.3. Definitions: The following terms and phrases, where used in these Rules, shall have the corresponding meanings, unless the context requires otherwise:

i. SAMA: the Saudi Arabian Monetary Authority.

ii. Rules: Large Exposure (LEX) Rules for Banks.

iii. Subsidiary: include a subsidiary where a bank owns more than 50% of its shareholding.

iv. Exposure: include both on and off-balance sheet exposures included in either the banking or trading books, and instruments with counterparty credit risk under the Basel risk-based capital framework. Banking and trading books have the same meaning as under the Basel risk-based capital framework.

v. Large Exposure: if the sum of all exposures values of a bank to a single counterparty or to a Group of Connected Counterparties is equal to or above 10% of the bank’s eligible capital base. The exposures values have to be measured and eligible capital base calculated as per requirements set out under these Rules.

vi. Eligible Capital Base: is the effective amount of Tier 1 capital fulfilling the criteria defined in the Basel III framework.

vii. Control Relationship: control relationship will be deemed to exist automatically if one entity owns more than 50% of the voting rights of another entity. In addition, banks must assess connectedness between counterparties based on control, using the following criteria: a. Voting agreements (e.g. control of a majority of voting rights pursuant to an agreement with other shareholders); b. Significant influence on the appointment or dismissal of an entity’s administrative, management or governing body, such as the right to appoint or remove a majority of members in those bodies, or a majority of members have been appointed solely as a result of the exercise of an individual entity’s voting rights;

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c. Significant influence on senior management, e.g. an entity has the power, pursuant to a contract or otherwise, to exercise a controlling influence over the management or policies of another entity (e.g. through consent rights over key decisions);

Banks are also expected to refer to criteria specified in appropriate internationally recognized accounting standards (The International Financial Reporting Standards - IFRS are applied to all banks in KSA) for further qualitatively based guidance when determining control.

Where control has been established based on any of these criteria, a bank may still demonstrate to SAMA in exceptional cases, e.g. due to the existence of corporate governance safeguards, that such control does not necessarily result in the entities concerned constituting a group of connected counterparties.

viii. Economic Interdependence: In establishing connectedness based on economic interdependence, banks must consider, at a minimum, the following qualitative criteria: a. Where 50% or more of one counterparty's gross receipts or gross expenditures (on an annual basis) is derived from transactions with the other counterparty (eg the owner of a residential/commercial property and the tenant who pays a significant part of the rent); b. Where one counterparty has fully or partly guaranteed the exposure of the other counterparty, or is liable by other means, and the exposure is so significant that the guarantor is likely to default if a claim occurs; c. Where a significant part of one counterparty's production/output is sold to another counterparty, which cannot easily be replaced by other customers; d. When the expected source of funds to repay each loan of both counterparties is the same and neither counterparty has another independent source of income from which the loan may be serviced and fully repaid.¹

¹ As amended by BCBS via its FAQ issued on September 29, 2016

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e. Where it is likely that the financial problems of one counterparty would cause difficulties for the other counterparties in terms of full and timely repayment of liabilities; f. Where the insolvency or default of one counterparty is likely to be associated with the insolvency or default of the other(s); g. When two or more counterparties rely on the same source for the majority of their funding and, in the event of the common provider's default, an alternate provider cannot be found. In this case, the funding problems of one counterparty are likely to spread to another due to a one-way or two-way dependence on the same main funding source.

Where a bank can demonstrate to SAMA that a counterparty who is economically closely related to another counterparty may overcome financial difficulties or even the second counterparty's default by finding alternative business partners or funding sources within an appropriate time period, the bank is not required to combine these counterparties to form a group of connected counterparties despite meeting some of the above criteria.

There are cases where a thorough investigation of economic interdependencies will not be proportionate to the size of the exposures. Therefore, banks are expected to identify connected counterparties on the basis of economic interdependence in all cases where the sum of all exposures (including guarantors) to one individual counterparty or a group of connected counterparties exceeds 5% of the eligible capital base.

ix. Group of Connected Counterparties: In some cases, a bank may have exposures to a group of counterparties with specific relationships or dependencies such that, where one of the counterparties were to fail, all of the counterparties would very likely fail. A group of this sort, referred to in these rules as a group of connected counterparties, must be treated as a single counterparty. In this case, the sum of the bank’s exposures to all the individual

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entities included within a group of connected counterparties is subject to the large exposure limit and to the regulatory reporting requirements.² Two or more natural or legal persons shall be deemed a group of connected counterparties if at least one of the following criteria is satisfied: a. The existence of a control relationship; or b. The existence of Economic interdependence. c. Other connections or relationships which, according to a bank’s assessment, identify the counterparties as constituting a single risk.

The bank shall assess the relationship amongst counterparties with reference to (a), (b) and (c) above in order to properly assess the existence and the extent of a group of connected counterparties.

Where control has been established based on any of these criteria, a bank may still demonstrate to SAMA in exceptional cases, e.g. due to the existence of specific circumstances and corporate governance safeguards, that such control does not necessarily result in the entities concerned constituting a group of connected counterparties.

x. Entities Connected with Saudi Government: means public sector entities treated as sovereigns under the Basel risk-based capital framework including Sovereign Wealth Funds (SWFs). However, any commercial undertakings majority owned by Saudi Government will be treated as normal commercial entities and therefore be subject to the exposure limits under these Rules.

xi. Commercial Undertakings Majority Owned by Saudi Government: commercial entities in which the Saudi Government or Entities Connected with Saudi Government owns (directly or indirectly) 50% or more of shareholdings.

² See section '7. Regulatory Reporting' of this circular

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2. Scope and Level of Application:

2.1. Level of Application: These rules shall be applicable to the following institutions: i. All locally incorporated banks licensed and operating in the Kingdom of Saudi Arabia ii. All foreign branches and subsidiaries of locally incorporated banks operating outside the Kingdom of Saudi Arabia. iii. All foreign banks operating in the Kingdom of Saudi Arabia.

While applying the rules to their subsidiaries and branches, the banks shall also take into account the legal and regulatory requirements of the concerned regulatory authorities.

These rules do not apply to Foreign Bank Branches that are subject to consolidated supervision by their home country supervisors in respect of credit concentrations and large exposure limits unless specifically stated. However, all foreign bank branches must detail their large exposure and risk concentration policies as well as the relevant high-level controls, and report their 50 largest exposures as per reporting requirements under Section 7 of these Rules. As part of its prudential oversight of the Kingdom of Saudi Arabia operations of a foreign bank branch, SAMA may discuss with the foreign bank branch’s parent and home supervisor any undue credit risk concentrations associated with the foreign bank branch’s Kingdom of Saudi Arabia operations.

These rules shall be applicable on a consolidated as well as standalone basis. They apply at the same level as the risk-based capital requirements are required to be applied as per SAMA’s Detailed Guidance Document relating to Pillar 1, June 2006,³ i.e. at every tier within a banking group. While applying the rules at a consolidated level, a bank must consider all exposures to third parties across the relevant regulatory consolidation group and compare the aggregate of those exposures with the group’s eligible capital base.

2.2. Scope of counterparties: A bank must consider exposures to any counterparty to comply with the exposure limits unless a specific exemption to any exposure is granted under these Rules.

³ See "Basel II - SAMA's Detailed Guidance Document relating to Pillar 1, June 2006"

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3. Governance and Risk Management

i. The Board of Directors of a bank is ultimately responsible for the oversight of the bank’s large exposures and risk concentrations and for approving policies governing large exposures and risk concentrations of the bank. ii. A bank is required to have policies and procedures on large exposures and risk concentrations. iii. A bank is required to conduct stress testing and scenario analysis of its large exposures and risk concentrations to assess the impact of changes in market conditions and key risk factors (e.g. economic cycles, interest rates, liquidity conditions or other market movements) on its risk profile, capital and earnings. iv. A bank is required to have adequate systems and controls in place to identify, measure, monitor and report large exposures and risk concentrations of the bank on a timely basis and large exposures and risk concentrations of the bank are reviewed at least quarterly. v. For exposures and counterparties that are excluded from the large exposure limits, a bank must have adequate processes and controls in place to monitor these excluded exposures. The bank is required to consider how the risks arising from these types of exposures are incorporated into its risk management framework, including establishing internal limits and triggers commensurate with its risk appetite.

4. Maximum Exposure Limits:

4.1. Exposure Limits: All banks are required to ensure compliance of the following exposure limits:

i. Single Counterparty: The sum of all exposures values a bank has to a single non-bank counterparty (excluding individuals, sole proprietorships and commercial undertakings majority owned by Saudi government) must not be higher than 15% of the banks available eligible capital base at all times.

ii. Group of Connected Counterparties: The sum of all exposures values a bank has to a group of connected non-bank counterparties must not be higher than 15% of the bank’s available eligible capital base at all times. Subject to the following: a. Where an individual/sole proprietorship/partnership is included within a Group of Connected Counterparties, the exposure limit specified under Section 4.1.iii below shall also be applicable, in addition to the overall group exposure limit. b. The sum of all exposures values a bank has to the group of connected counterparties where a commercial undertakings majority owned by Saudi government is included can be higher than 15% of the bank’s eligible capital base subject to the limit specified in 4.1.v.

Furthermore, the sum of a bank’s exposures to the entities included within a group of connected counterparties will also be subject to the regulatory reporting requirements as specified under Section 7 of these Rules.

iii. Individual/Sole proprietor: The sum of all the exposures values a bank has to an individual or a sole proprietorship or a partnership must not be higher than 5% of the banks available eligible capital base at all times.

iv. Banks: The sum of all the exposures values a bank has to another bank must not be higher than 25% of the lending bank’s available eligible capital base at all times. However, If the lending bank and/or the counterparty bank are/is Domestically - Systemically Important Banks (D-SIBs), or Globally - Systemically Important Banks (G-SIBs) as defined in Appendix VI, then the sum of all exposures of the lending Bank to its counterparty bank cannot exceed 15% of the lending bank’s available eligible capital base at all times.

v. Commercial Undertakings Majority Owned by Saudi Government: The sum of all exposures values a bank has to a commercial undertakings majority owned by Saudi Government must not be higher than 25% of the bank’s available eligible capital base at all times;

vi. Aggregate Large Exposures: The aggregate of all Large Exposures shall not exceed 6 times of the bank’s eligible capital.

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4.2. Measurement of Exposures and Capital Base: The exposures must be measured as specified in Section 5 of these Rules. The eligible capital base is the effective amount of Tier 1 capital fulfilling the criteria defined in Section A of the “Finalized Guidance Document Concerning the Implementation of Basel III” ⁴.

4.3. Breaches of Limits: Any breaches of the exposure limits, must be communicated immediately to SAMA. The communication to SAMA must also include the bank’s action plan to bring the exposure to within the breached limit. Furthermore, any such breaches may attract punitive supervisory action depending upon their materiality.

In exceptional circumstances where a bank’s proposed exposure to a counterparty is likely to exceed any specific limits in these rules, the bank must obtain approval from SAMA prior to undertaking that exposure. In such cases, the bank must provide SAMA with the assessment of the following:

a. The concentration risks involved with exceeding the large exposure limits and why the proposed exposures will not unreasonably expose the bank to excessive risk; and b. How the proposed exposure is consistent with its large exposures and risk concentration policies.

SAMA may impose additional concentration risk capital requirements on exposure amounts that exceeds any specific limits in these rules.

5. Measurement of Exposures Values:

5.1. General Measurement Principles: Banks shall adhere to the following principles in measuring the values of exposures: i. The exposure values to be considered for identifying large exposures to a counterparty are all those exposures defined under the risk-based capital framework.

⁴ The above mentioned guidelines is available at the following link on SAMA's website: http://www.sama.gov.sa/en-US/Laws/Pages/SAMA_Basel_Program_Sec2.aspx

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Accordingly, banks must consider both on and off-balance sheet exposures included in either the banking or trading books, and instruments with counterparty credit risk under the risk-based capital framework; ii. In case the counterparty is part of a Group of Connected Counterparties, the values of exposures to all individual counterparties within a group of connected counterparties must be aggregated. iii. An exposure amount to a counterparty that is deducted from capital must not be added to other exposures to that counterparty for the purpose of the large exposures limit. This general approach does not apply where an exposure is 1,250% risk-weighted. When this is the case, this exposure must be added to any other exposures to the same counterparty and the sum subject to the large exposures limit, except if this exposure is specifically exempted for other reasons.

5.2. Eligible credit risk mitigation (CRM) techniques: Eligible credit risk mitigation techniques for large exposures purposes are those that meet the minimum requirements and eligibility criteria for the recognition of unfunded credit protection⁵ and financial co