CBE Regulation Book 3.1 - Capital Adequacy Standard Credit Risks

Chapter One: Capital Adequacy Standard Section Four: Market Risks

1/4 General Conditions for Application

1/1/4 Banks must apply the Standardized Approach to calculate the capital requirement for market risks through a building block approach. Capital requirements for each type of market risk are calculated separately according to the methods provided herein and then aggregated to reach the total capital requirement for market risks.

1/2/4 Banks must determine their investments related to the trading portfolio when calculating the capital requirement, provided that each bank has a clear internal policy specifying the basis for distinguishing between the trading and non-trading portfolios. This must be in accordance with procedures approved by the Board of Directors and consistent with Central Bank of Egypt instructions.

1/3/4 The trading portfolio must include: 1/3/1/4 Positions in financial instruments acquired or held with the intention of selling or benefiting from short-term price fluctuations or arbitrage opportunities between expected or actual differences in prices over a short period, as well as any other prices that may affect the trading portfolio. 2/3/1/4 Positions in financial derivatives used for hedging, provided that:

• These positions are used to hedge positions in other parts of the trading portfolio.
• These positions are used to hedge positions in the non-trading portfolio, provided that the hedging transaction is an internal transaction between the bank's own books (departments). In this case, the capital requirement for the risks associated with this internal transaction is calculated separately and is not included in the general capital requirement for the trading portfolio. The bank must hedge positions in the non-trading portfolio with external counterparties within the trading portfolio limit only, and they are excluded when calculating the capital requirement for market risks.

The capital requirement for counterparty credit risk is included in the calculation of the capital requirement for market risks in this regard.

1/4/4 Financial instruments held for trading must be free of any conditions that hinder their trading and must be eligible for full hedging operations.

1/5/4 Banks are exempt from calculating the capital requirement for market risks if the positions held for trading do not exceed 5% of total assets and have a value not exceeding EGP 50 million in all cases. This exemption applies only to the trading portfolio as a whole. The capital requirement for exchange rate risk is calculated.

1/6/4 The Central Bank of Egypt allows exempted banks to exceed the aforementioned exemption limits only in cases of facing positions with a maturity of up to 3 months. In the event that this exceedance continues for more than 3 months due to adverse conditions, the bank becomes obligated.

1/7/4 Banks subject to the capital requirement for positions held for trading remain obligated to calculate that requirement in the event of an exceptional circumstance leading to exceeding the aforementioned exemption limits.

1/8/4 Banks must evaluate positions held for trading according to prevailing market prices (Mark-to-Market) on a daily basis at a minimum, in accordance with accounting rules. In the absence of sufficient data on market prices, banks must use pricing models (Mark-to-Model), provided that adequate care is available when using these models.

1/9/4 Banks must adhere to the following criteria when using pricing models to evaluate positions:

• Full oversight by senior management over all aspects related to trading positions evaluated using models.
• Definition of model parameters through reliable sources that reflect market conditions, with periodic evaluation of these parameters.
• Availability of a specific methodology for valuing financial instruments.
• Periodic review of the model used to determine its accuracy and verify the prices used. Additionally, daily valuation of prices extracted from the model must be performed.

If the model is developed based on appropriate assumptions, these assumptions must be evaluated by specialists with high efficiency and independence related to their work.

2/4 Capital Requirement for Debt Instruments Risks

Banks must consider the following when measuring specific risks for debt instruments held for trading:

• Debt instruments whose value depends on interest rates of government bonds and treasury bills, including derivatives linked to interest rates, such as government interest rate swaps, contracts, and derivatives linked to instruments, are considered only for hedging purposes according to instructions of the Central Bank of Egypt as per clause 2/3/1/4 of this Chapter.

The capital requirement for debt instruments risks consists of the capital requirement for general market risks and specific risks for debt instruments as follows:

1/2/4 Capital Requirement for General Market Risks for Debt Instruments

The capital requirement for general market risks for debt instruments is calculated using one of the following two methods: 1/1/2/4 Maturity Method 2/1/2/4 Duration Method

Banks must apply the Maturity Method in the first phase of implementing Basel regulations. They are allowed to apply the Duration Method in the subsequent phase only after obtaining approval from the Supervision and Inspection Sector of the Central Bank of Egypt. In the event that approval is issued to any bank to apply the Duration Method, it is allowed to revert to the Maturity Method upon submitting justifications to the Central Bank of Egypt, subject to the Bank's decision.

1/1/2/4 Maturity Method

Banks must use the maturity ladder to calculate general risks for debt instruments. The capital requirement is calculated for each type of main currency for positions in debt instruments, representing 5% of each limit. For other foreign currencies, the bank relies on having a maturity ladder for all currencies with a total value less than 1% of total assets.

Banks must follow the following steps for this method: 1/1/1/2/4 Identify positions held for trading, including:

• Debt instruments, including treasury bills.
• Positions arising from derivative operations exercised with financial papers.
• Positions arising from derivative operations not exercised with financial papers.

The net position for each clause of the aforementioned clauses is calculated by: a) Netting surplus and deficit positions in all aspects, where the nature of the instrument and its maturity date and yield rate allow netting. In the case of derivatives, netting is allowed with the financial instrument subject to the contract. Netting is not allowed between issuers of debt instruments, even if the coupons differ, due to differences in liquidity and characteristics of those bonds leading to price changes. b) Netting surplus and deficit positions for all types of instruments to reach a net non-matching position representing the largest value without classifying the remaining value from the netting process as a surplus or deficit according to the reference. c) Aggregating each surplus and deficit position for each time limit according to the following table (Table 1-4).

2/1/1/2/4 Distribute the net positions of surplus and deficit obtained in the previous step across appropriate time bands according to their suitability. As shown in the table below, the time period is divided into 13 periods relative to debt instruments with yields, and 15 periods for those with yields less than 3% of the coupon, or without a coupon.

• Aggregate surplus and deficit positions for each time period.
• Multiply the total net surplus or deficit for each time period by the risk weight specific to it (Table 1-4).

Zones Time Bands Risk Weight Coupon >= 3% or Coupon < 3% or No Coupon

First Zone Less than 1 month 0% 1 month to 3 months 0.2% 3 months to 6 months 0.4% 6 months to 1 year 0.7%

Second Zone 1 year to 2 years 1.25% 2 years to 3 years 1.75% 3 years to 4 years 2.25%

Third Zone 4 years to 5 years 2.75% 5 years to 7 years 3.25% 7 years to 10 years 3.75% 10 years to 15 years 4.5% 15 years to 20 years 5.25% 20 years to 25 years 6.0% More than 25 years 8% More than 50 years 12.5%

3/1/1/2/4 Vertical Disallowance

Netting is performed between weighted surplus positions and weighted deficit positions with risk weights, such that the smaller of the deficit or surplus position represents the matched position. The difference between them represents the unmatched position for each time period.

4/1/1/2/4 Capital Requirement for Matched Positions in Each Time Period

The capital requirement is calculated by multiplying the sum of matched positions with risk weights by 10% for each time period.

5/1/1/2/4 Horizontal Disallowance within Zones

The total weighted surplus positions and total weighted deficit positions are calculated. The minimum value between the total surplus positions and total deficit positions within each zone is determined. The difference between them is classified as a matched position (Matched position) for the zone and an unmatched position (Unmatched position) for the zone.

6/1/1/2/4 Capital Requirement for Matched Positions within Zones

The capital requirement is calculated by multiplying the matched positions with weighted values for each zone according to the ratios in the following table (Table 2-4), then summing the values of the zones together.

Table 2-4

Unmatched Positions between Zones

Unmatched weighted positions are netted by comparing the unmatched position in the first zone with a similar position in the second zone, resulting in one of the following two cases:

Case A: The unmatched positions in the first and second zones are of the same nature.

• In this case, the minimum value between them is taken as a matched position and classified in one of the two zones. The difference between these two positions is calculated as an absolute value and classified in one of the two zones.

Time Periods within Zone	Unmatched Positions between Adjacent Zones	Unmatched Positions between First and Third Zones
First Zone
Less than 1 month	40%	150%
1 month to 3 months
3 months to 6 months
6 months to 1 year
Second Zone
1 year to 2 years	30%
2 years to 3 years
3 years to 4 years
Third Zone
4 years to 5 years	30%
5 years to 7 years
7 years to 10 years
10 years to 15 years
15 years to 20 years
More than 20 years

Then, comparison is made based on the larger value of the unmatched positions in the first or second zone. The difference resulting from comparing the unmatched position in the third zone with the other will yield one of the following results:

• If the difference value is of the same nature as the unmatched position in the third zone, the sum is calculated as a surplus/deficit and represents the final unmatched position.
• If the difference value is of different nature from the unmatched position in the third zone, the minimum value between it and the matched position in the third zone is taken and classified in the other direction from the first or second zone. The difference between any of the two values is calculated. The direction of the unmatched position in the third zone and the direction between the first and second zones represent the final unmatched position.

Case B: The unmatched positions in the first and second zones are of different nature. The following must be followed in this case:

• If the weighted unmatched position in the third zone is of the same nature as the unmatched positions in the first and second zones, the sum of the unmatched positions in the first and second zones becomes the final unmatched position.
• If the weighted unmatched position in the third zone is of different nature from the unmatched positions in the first and second zones, the difference between the unmatched positions in the first and second zones is found. This difference is classified in one of the two zones with the largest absolute value. The difference between the matched positions in the first and third zones is the final unmatched position.
• If the difference is classified in the second zone and is of the same nature as the unmatched position in the first zone, their sum is calculated and represents the final unmatched position.

7/1/1/2/4 Capital Requirement for Matched Positions between Zones

The capital requirement is calculated by multiplying the matched weighted positions between the third zones by the factors specified in Table 2-4. Then, the results mentioned above are summed together.

8/1/1/2/4 Capital Requirement for Final Unmatched Position

The capital requirement is calculated by multiplying the final unmatched position by 100%.

9/1/1/2/4 Total Required Capital Calculation

The total required capital is calculated by summing the results of the steps in clauses 4/1/1/2/4, 6/1/1/2/4, 8/1/1/2/4, and 9/1/1/2/4 of this Chapter.

2/1/2/4 Duration Method

This method is considered more accurate as it depends on calculating the price sensitivity for each position separately, where the bank is exposed to interest rate fluctuations due to the modified duration of the financial instrument. The capital requirement for this method is calculated according to the change in interest rates on the market as follows:

1/2/1/2/4 The modified duration for each instrument is calculated as the present value of cash flows weighted by the time to maturity of those cash flows divided by the present value of those cash flows, according to the following equations:

Modified Duration (MD) = D/ (1+r)

Where: D = Duration in years r = Yield rate Ct = Cash flows for each period t = Time remaining until cash flow maturity n = Number of periods for cash flows

2/2/1/2/4 The appropriate zone for each instrument is determined according to the modified duration calculated in the previous step, as shown in the following table (Table 3-4):

Time Zone of Modified Duration for Assumed Change in Interest Rate
First Zone: Change <= 1%
Second Zone: 3.6 years to 0.85 years
Third Zone: > 3.6 years

3/2/1/2/4 The weighted modified duration for each instrument is calculated through the equation: Weighted Modified Duration = Assumed Change in Interest Rate for the Zone Where the Instrument Falls × Modified Duration of the Instrument According to what is shown in Table 3-4 above.

4/2/1/2/4 The total weighted modified durations for all instruments in each of the three zones are calculated together for surplus and deficit positions.

5/2/1/2/4 The total market values of financial instruments are multiplied to reach the limit for each zone according to the weighted average modified duration for those instruments. The weighted average modified duration must be calculated as follows: Weighted Average Modified Duration = Total Weighted Modified Durations of Instruments / Average Modified Duration of Instruments According to the previous step (Clause 4/2/1/2/4) for the same zone.

6/2/1/2/4 Netting is performed between weighted surplus and deficit positions of modified durations. The result obtained in the previous step is the value for this period. The matched position is the smaller position, and the difference represents the unmatched position (Unmatched position).

7/2/1/2/4 The steps mentioned in clauses 7/1/1/2/4 to 9/1/1/2/4 are followed.

8/2/1/2/4 The total capital requirement for general risks for debt instruments is calculated by adding the result of multiplying the total matched positions in the third zone by 2% to the total capital requirements calculated according to clause 7/2/1/2/4 above.

2/2/4 Capital Requirement for Specific Risks of Debt Instruments

1/2/2/4 Government Debt Instruments

1/1/2/2/4 This category includes debt instruments issued or guaranteed by central governments, including all forms of government debt instruments such as local governments or central banks, including treasury bills and government bonds held for trading.

2/1/2/2/4 A risk weight of zero is applied to debt instruments issued or guaranteed by the Central Bank of Egypt or the Egyptian Government in the local currency. In the case of issuing debt instruments by the Central Bank of Egypt or the Egyptian Government in foreign currencies, the capital requirement is determined based on the credit rating of one of the institutions recognized by the Central Bank of Egypt instructions for credit risks, according to the remaining maturity of those instruments.

In the case of issuing debt instruments by central governments other than the Egyptian Government or other local governments or central banks, as shown in the following table (Table 4-4), the capital requirement is determined based on the credit rating of the issuing entity for the state according to the credit rating of those instruments in the table.

Table 4-4

Categories	External Credit Rating Institutions (Recognized by Credit Risk Instructions)	Remaining Period until Maturity	Capital Requirement for Debt Instruments
Government Debt	AAA to AA-	<= 6 months	0%
	A+ to BBB-	> 6 months to <= 24 months	0.31%
		> 24 months	1.25%
	BB+ to B-	> 24 months	2.0%
	B-	> 24 months	10.0%
Low Risk Debt Instruments (Qualifying)	No Credit Rating	<= 6 months	0.31%
		> 6 months to <= 24 months	1.25%
		> 24 months	2.0%
High Risk Debt Instruments (Non-qualifying)	BB+ to BB-	> 24 months	10.0%
	BB-	> 24 months	12.0%
	No Credit Rating	> 24 months	10.0%

2/2/2/4 Low Risk Debt Instruments

1/2/2/2/4 This category includes debt instruments issued by public sector entities and banks, in addition to other debt instruments meeting one of the following conditions:

• Must have a credit rating of at least investment grade, such as BBB from Standard & Poor's, Baa from Moody's, or at least two issuers from recognized credit rating institutions or those listed in the Credit Risk Instructions.
• Must have a credit rating of investment grade from one of the recognized credit rating institutions, and the credit rating from other recognized credit rating institutions must not be less than investment grade, or recognized by the Central Bank of Egypt.
• It is not considered unrated if the bank believes it has a credit rating not less than investment grade, provided that approval is obtained from the Central Bank of Egypt.

4/2/2/2/4 Banks must align their ratings with those from recognized credit rating institutions.

5/2/2/2/4 In the event of a difference in ratings granted for government debt instruments from a recognized institution, the bank must take the minimum rating considered.

The instrument must be issued by an issuer recognized by the Central Bank of Egypt and traded on a recognized financial paper market.

2/2/2/2/4 The capital requirement for this category of debt instruments is determined according to the remaining maturity of those instruments, as shown in Table 4-4 above.

3/2/2/4 High Risk Debt Instruments (Non-qualifying)

1/3/2/2/4 This category includes debt instruments issued by issuers of high risk, which do not meet the criteria mentioned in the previous categories for government debt instruments with low risk.

2/3/2/2/4 The capital requirement for those financial instruments is given as per the table mentioned above (Table 4-4) for government debt instruments with non-investment grade credit ratings.

3/4 Capital Requirement for Equity Risks

1/1/3/4 Banks must calculate a separate capital requirement for each of the general and specific risks for shares, including derivatives on shares and share indices.

2/1/3/4 Netting is allowed between matched positions of surplus and deficit for the same issuer and deficit for each market. The total net surplus and total net deficit are entered for each market, local or foreign, according to the model. The capital requirement for equity risks is calculated as follows:

• For General Risks: The net position represents 10% of the difference in net positions of shares, which is the absolute value between the net surplus positions and the total net deficit positions.
• For Specific Risks: The total position represents 10% of the total of net surplus positions and net deficit positions of shares.

3/1/3/4 The capital requirement for specific risks for shares is calculated at 5%, provided that the share portfolio held for trading represents more than 10% of the share positions and that the shares in that portfolio are highly liquid and sufficiently diversified.

1/3/1/3/4 Diversification Conditions for Calculating the Capital Requirement for Specific Risks for Shares:

• a) The value of shares with the same characteristics of the issuer must not exceed 10% of the total portfolio, or shares held for trading and traded in each market.
• b) If the value of shares with the same characteristics of the issuer represents between 10% and 20%, the share portfolio held for trading and traded in each market must not exceed 50% of the total of those positions in the portfolio.

2/3/1/3/4 High Liquidity Conditions for Calculating the Capital Requirement for Specific Risks for Shares:

• a) Those shares must be classified within the index traded on the Egyptian Exchange, specifically the main index of the Exchange.
• b) For shares traded on organized foreign exchanges:
• If the shares are traded in one of the EU countries or G10 countries, they can be considered highly liquid.
• If the shares are traded in other countries, they can be considered highly liquid if the turnover rate in these markets is not less than 7.5% of the average market capitalization over the previous six months. The turnover rate is calculated as the ratio of the trading volume value to the market capitalization. The turnover rate must be calculated at least every six months, and the bank must keep a record of the data used in calculating the rate for the same period.

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4/4 Capital Requirement for Investment Funds to Meet Risks

1/4/4 Methods for Measuring Capital Requirements for Investment Fund Documents

a) Banks must apply the General Method to calculate the capital requirement for investment fund documents if they do not meet the criteria mentioned above. These methods may only be applied when the specified criteria are met, either in full or partially.

b) Banks must obtain approval from the Central Bank of Egypt to use the specified methods in full or partially for investment fund documents issued by foreign countries not included in the G10 group. This applies provided that the conditions required for applying these documents are met, as confirmed by the Central Bank.

c) Banks are permitted to net positions between surpluses and deficits within a single investment fund. Banks are also permitted to net financial investments between the fund and other positions held by the bank, unless the bank applies the Full Detailed Method.

d) In cases where the fund's basic system allows borrowing for the purpose of increasing its investments, banks must calculate their capital requirements on the increase in the fund's investments resulting from borrowing from non-owners.

1/1/4/4 Specified Methods

1/1/1/4/4 Full Look Through Method

• Banks must use this method when they have complete knowledge of the fund's investments. The capital requirement for general risks is calculated according to the fund's components.
• The fund's investments are treated as trading book investments, and the capital requirement is calculated for each financial instrument comprising the document according to its distribution in the model mentioned above.

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• Banks may net positions between different financial instruments in the fund for a sufficient number of fund documents, provided the bank owns other positions and can dispose of or redeem the investments in these documents.

2/1/1/4/4 Partial Detailed Method

• Banks must use this method when they do not have complete knowledge of the fund's investments. However, the fund's basic system determines the distribution of the fund's capital, and then the capital requirement for general risks is calculated according to the types of different investments as follows:
  • Assume the fund begins investing in areas of investment with high risk requirements within the framework of maximum limits. Thus, the capital requirement is calculated for those investments according to the maximum limits allowed by the basic system.
  • Investments are gradually reduced in risk degree until the maximum allowed limits are reached. The capital requirement for general risks is calculated for the fund's investments as a whole according to those investments.

2/1/4/4 General Method (Residual Method)

• The capital requirement for general risks is calculated based on a ratio of 32% of the total fair value of investment fund documents owned by the bank for which the criteria for applying the specified methods are met.

2/4/4 Criteria for Using Specified Methods

1/2/4/4 The funds must be established through companies operating in the Arab Republic of Egypt, or established in one of the countries or subject to the supervision of one of the regulatory authorities within it, and classified as G10 major countries.

2/2/4/4 The following conditions must be met:

a) The fund's charter must include: * The types of investments authorized for the fund in it. * The specific limits for each type of investment. * The maximum limit for borrowing, if allowed to use financial leverage.

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b) The fund's establishment must be confirmed by quarterly financial statements and reports that evaluate assets, liabilities, profits, and losses over a specified period.

c) The fund's documents must be liquid for redemption on a daily and cash basis upon request.

d) A separation must be made between the assets owned by the company responsible for management and the assets owned by the fund.

5/4 Capital Requirement for Settlement Risks

Banks must undertake to calculate the capital requirement for settlement risks for two types of operations:

• Delivery versus payment
• Non-delivery versus payment – Free deliveries

In the event of a failure in the settlement or netting system applied, the Central Bank of Egypt may postpone the application of the capital requirement for settlement risks temporarily to rectify this failure, provided it is attributed to a technical failure and not the failure of the other party to complete the settlement process. This is to monitor the bank's situation regarding the regularity of its settlement operations.

1/5/4 Delivery versus Payment Operations

1/1/5/4 These operations arise when payment is made in cash against the delivery of the instrument subject to the contract. In the event of failure to carry out the settlement process, the bank incurs a loss equal to the difference between the agreed price for receipt or payment of the currency or financial instrument and its market value at the time of delivery.

2/1/5/4 The capital requirement for risks in these operations is calculated by multiplying the value of the operations by a factor based on the number of days after the settlement date as shown in the following table (Table 5-4):

Table (5-4)

Number of Days After Settlement Date	Capital Requirement (%)
5 – 15	10
16 – 30	50
31 – 45	75
46 and more	100

2/5/4 Free Delivery Operations

1/2/5/4 These operations arise when payment is made in cash before the receipt of the instrument subject to the contract. In this case, the loss is equal to the fair value of the instrument subject to the contract before delivery. If the instrument subject to the contract is delivered before receiving the cash or consideration paid, the currency or financial instrument delivered is received without paying the cash or consideration.

2/2/5/4 Banks that have delivered currencies or financial instruments or made cash payments must, on the same day or the next working day up to the fourth working day, calculate the capital requirements for those operations using risk weights according to the Credit Risk Instructions for the counterparty:

Capital Requirement	Settlement Risks	Free Delivery Operations
Value of Exposure to Instrument = Cash or Delivery Paid	Counterparty Risk Weight x Credit Risk Instructions	10 X %

3/2/5/4 Banks that have delivered currencies or financial instruments or made cash payments must, after four working days have passed from the agreed receipt date, receive the consideration. Any difference representing a loss to the bank between the fair value of the instrument for which payment was made and the fair value of the instrument for which cash was received or delivery was made must be paid to the bank's capital.

6/4 Capital Requirement for Foreign Exchange Rate Risks

3/5/4 Method for Measuring Capital Requirement for Foreign Exchange Rate Risks

Banks must calculate the capital requirement for foreign exchange rate risks at a rate of 10% of the total net foreign exchange positions, provided that the total net foreign exchange positions at the bank exceed 2% of the bank's capital base calculated according to the instructions for the capital base issued by the Central Bank of Egypt.

7 Circular letters numbers 334 dated September 16, 1993, 347 dated May 10, 1999, and 348 dated December 10, 1999 regarding positions.

1/1/6/4 The total net foreign exchange positions are calculated according to the following steps:

• The net position for each currency is calculated separately based on the difference between the total positions. "Total Surplus Positions" represents the sum of surplus positions in foreign currency assets. "Total Deficit Positions" represents the total deficit positions in foreign currency liabilities, including forward purchases and sales obligations and any other operations arising from rights or obligations to sell assets or buy rights of the same currency, as well as equity rights in the same currency found.

2/1/6/4 The net foreign exchange positions are evaluated in the local currency (Egyptian Pound) according to prevailing market exchange rates. Gold balances are also evaluated at prevailing gold prices.

3/1/6/4 The net surplus positions and net deficit positions are summed at the level of all currencies.

4/1/6/4 The total net foreign exchange positions at the bank represents the greater of the net surplus positions or the net deficit positions, whichever is larger, added to the absolute value of gold.

1/6/4 Positions Excluded from Calculating Foreign Exchange Rate Risks

1/2/6/4 Banks are permitted to exclude any positions from calculating the net foreign exchange positions, provided that the capital requirement for those positions meets the following conditions:

• These positions are not for trading purposes.
• The sole purpose of these positions is to protect the bank's capital adequacy rate against negative effects of changes in foreign exchange rates, wholly or partially.
• The treatment of the hedging process remains unchanged throughout the original holding period.

2/2/6/4 In addition to the above, the capital requirement for foreign exchange rate risks is calculated for the following positions:

• Items deducted from the bank's capital when calculating the capital base, such as investments in subsidiaries denominated in foreign currencies that are consolidated in the bank's balance sheet on a consolidated basis.

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• Other long-term contributions denominated in foreign currencies for which declarations are made in the financial statements at historical cost.

7/4 Capital Requirement for Option Contract Risks

1/7/4 Banks must use the Simple Method to calculate the capital requirement for option contract risks. The purpose of these contracts must be only for hedging, according to the instructions for the bank. This applies under the general conditions shown in clause 2/3/1/4 of this chapter, resulting from one of the following two possibilities:

• When it is a "long futures/forward operation accompanied by a sale right" / "long financial instrument" -> Surplus positions in the bank's portfolio of the financial instrument.
• When it is a "short futures/forward operation accompanied by a purchase right" / "short financial instrument" -> Deficit positions in the bank's portfolio of the financial instrument.

2/7/4 The capital requirement for risks of purchased option contracts is calculated according to the Simple Method by multiplying the market value of the financial instrument subject to the contract by the sum of the capital requirement ratios for general risks and specific risks for that instrument, minus any positive value of the option contract (positive intrinsic value).

Capital Requirement = (Market Value of Financial Instrument Subject to Contract x Sum of Capital Requirement Ratios for General and Specific Risks for the Financial Instrument Subject to Contract) - Positive Value of Option Contract

If the result of the previous equation is negative, the bank does not calculate any capital requirement for this matter.

8 Positive intrinsic value of an option contract represents the positive difference between the market price of the financial instrument subject to the contract and the strike price. For purchased call options, it is the positive difference between the market price and the strike price if the bank is eligible. For purchased put options, it is the positive difference between the strike price and the market price.

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8/4 Annexes

Annex (1) Treatment of Interest Rate Derivatives

Banks must take into account positions in financial derivatives linked to interest rates for hedging purposes only, according to the general conditions shown in clause 2/3/1/4 of this chapter for application to the Central Bank of Egypt instructions.

1. Netting Rules for Interest Rate Derivatives

Banks are permitted to net surpluses and deficits between identical instruments, currencies, and maturity dates, allowing differences in the following derivatives:

• Futures: Netting between positions in contracts with the same notional value or financial instrument, and the difference between the maturity dates of the two contracts is at most 7 days.
• Swaps and FRAs (Forward Rate Agreements): For contracts on forward interest rate swap agreements, the reference interest rate is the same, and the difference between coupon returns does not exceed 15 basis points for these contracts to be considered similar.
• Swaps, FRAs, and Forwards: For positions with fixed interest rates or repricing dates, the remaining period until the maturity date must follow the following limits:
  • If the remaining period until the maturity date for both positions is less than one month -> The positions are considered to have the same repricing date.
  • If the remaining period until the maturity date for both positions ranges between one month and one year -> The difference between the repricing dates must not exceed 7 days.
  • If the remaining period until the maturity date for both positions is more than one year -> The difference between the repricing dates must not exceed 30 days.

2. Calculating Capital Requirement for Interest Rate Derivative Risks

Derivatives operations affecting interest rates must be converted into positions in the financial instruments subject to the contract. They are treated as a mix of surplus and deficit positions with equal values. The capital requirement for general risks is calculated for them according to the methods for calculating capital requirements for debt instruments in clauses 1/2/4 and 2/2/4 of this chapter, based on the remaining period until maturity.

• Specific risks for derivative positions are calculated only when the contract subject is a financial instrument. For example, in the case of an interest rate swap where the contract subject is an interest rate, no specific risk is calculated. However, for a swap based on a bond yield, specific risks are calculated for the bond subject to the contract.

Examples:

a) Derivatives operations through which fixed interest rate flows are exchanged for variable interest rate flows. These are treated as a mix of assets and liabilities with fixed interest rates and assets or liabilities with variable interest rates. Banks must record them as a surplus or deficit position reflecting the fixed interest rate obligation or asset in the time period until the repricing date, and the variable interest rate asset or liability in the time period until maturity.

b) For other derivatives operations, banks must record a surplus or deficit position in the time period until the settlement date reflecting the time period until the contract's maturity date.

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Annex (2) Treatment of Equity Derivatives

Banks must take into account positions in financial derivatives linked to equities for hedging purposes only, according to the general conditions shown in clause 2/3/1/4 of this chapter for application to the Central Bank of Egypt instructions.

1. Calculating Capital Requirement for Equity Derivative Risks

Equity derivatives are converted into positions in the specified financial instruments subject to the contract for the purpose of calculating capital requirements for general risks as follows:

• Acknowledge forward contracts on equities linked to them at their market values.
• Acknowledge forward contracts on stock indices using the market value of the portfolio of equities subject to the contract as the stock index.
• Treat equity swap contracts as two contractual values.

9 For example, if the bank enters into an equity swap, it receives the change in the value of a specific stock index in exchange for paying the value of another stock index. In this case, the first party has a surplus position, and the second party has a deficit position. If the swap involves receiving or paying a change in the value of a specific stock index in exchange for receiving or paying a fixed interest rate, the variable portion is classified under debt instruments according to the time period indicated for them in the general risks capital requirement calculation.

2. Treatment of Equity Index Derivatives

• Banks must take equity index derivatives into account when calculating capital requirements for equity risks. To calculate the net positions and total positions, equity index derivatives can be treated either as a single financial instrument or divided into several components. In this case, netting between positions representing the equities constituting the index is allowed with other operations related to the same equities.
• Banks are permitted to net derivatives operations on indices provided that the index represents the full value of the index and does not fall below 90% of the index's market value.
• Banks are not permitted to divide equity index derivative contracts that cannot be divided into their basic components - traded in an organized market with sufficient diversity - reflecting the market conditions of the index. Such indices are considered sufficiently diversified. Consequently, indices representing sectors are not taken into account for consideration in general terms.

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