Rules on Large Exposures of Banks

General Department Of Banking Control

Banking Policy Department
February 2018

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Table of Contents

Contents	Page No.
1. General Requirements	3
1.1. Introduction	3
1.2. Definitions	3
1.3. Objectives of the Rules	8
2. Scope and Level of Application	8
2.1. Institutional Coverage	8
2.2. Level of Application	9
2.3. Scope of Counterparties	9
3. Maximum Exposure Limits	10
3.1. Exposure Limits	10
3.2. Measurement of Exposures and Capital Base	12
3.3. Breaches of Limits	12
4. Measurement of Exposures Values	12
4.1. General Measurement Principles	12
4.2. Eligible Credit Risk Mitigation (CRM) techniques	13
4.3. Recognition of CRM techniques in reduction of original Exposure	14
4.4. Recognition of exposures to CRM providers	15
4.5. Treatment of Specific Measurement Issues	15
4.6. Exposures Exempted from Exposure Limits	16
5. Exposure to Related Counterparties	17
6. Additional Requirements	18
7. Regulatory Reporting	19
8. Implementation	20
9. Sanctions	20
10. Effective Date	20
11. Annexures	21

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Rules on Large Exposures of Banks

1. General Requirements:

1.1. Introduction:

These Rules are issued by 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 14/10/1406H.

These Rules sets out the minimum requirements on large exposures including the limits on a bank’s exposures to single counterparties, groups of connected counterparties and related 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 regarding Limits on Credit Exposures issued vide SAMA Circular of June 1994.

1.2. 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 Agency.

ii. Rules: Rules for Large Exposures of 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 Common Equity Tier 1 capital fulfilling the criteria defined in Part 1 of 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 supervisory 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;

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 person (e.g. through consent rights over key decisions);

Banks are also expected to refer to criteria specified in appropriate internationally recognized accounting standards 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 specific circumstances and 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 one counterparty makes to another is the same and the counterparty does not have another source of income from which the loan may be fully repaid;

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.

Banks will be required to 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, and thus the bank does not need 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 possible 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, were one of the counterparties to fail, all of the counterparties would very likely fail. A group of this sort, referred to in this framework 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 entities included within a group of connected counterparties is subject to the large exposure limit and to the regulatory reporting requirements.

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.

The bank shall assess the relationship amongst counterparties with reference to (a) and (b) 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. Related Party: any party that the bank exerts control over or that exerts control over the bank, including, inter-alia, the following:

a. Members of Board of Directors, Members of Shariah Committees or Boards, Key Executives/members of Senior Management, Major Shareholders and External Auditors of the Bank and their dependent family members;

b. Un-incorporated establishments in which any Director, Members of Shariah Committees or Boards, External Auditor, Major Shareholder, or Key Executive/member of Senior Management of the Bank or any of their dependent family members is a partner or manager or has a direct financial interest or is a guarantor;

c. Affiliated or Associated companies and partnerships: These include establishments that are connected to the Bank by a common parent or a controlling shareholder.

Where dependence criteria for family members has been identified based on a and b above, a bank may still demonstrate to SAMA in exceptional cases, that the family members clearly operate all business activities independent of each other with no economic interdependence, financial support or shareholding from the other family member.

xi. Major Shareholder: a person who directly or indirectly owns, controls or has power to vote more than 5% of the voting shares of the bank granting the facility

xii. Entities Connected with Saudi Government: includes public sector entities treated as sovereigns under the Basel risk-based capital framework. 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.

xiii. Dependent Family Members: means first-degree relatives including parents, spouse and offspring.

1.3. 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.

2. Scope and Level of Application:

2.1. Institutional Coverage:

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 majority owned subsidiary (ies) of locally incorporated banks operating in the financial sector

iii) All foreign branches of locally incorporated banks

iv) Branches of foreign banks operating in the Kingdom

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.

When implementing the Rules, Branches of foreign banks operating in the Kingdom are only required to put in place internal policies to ensure reasonable diversification of their exposures, and to report their 50 largest exposures as per reporting requirements under Section 7 of these Rules.

2.2. Level of Application:

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 following SAMA’s Detailed Guidance Document relating to Pillar 1, June 2006, 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.

2.3. 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. The only exposures to certain counterparties that are exempted from the application of these Rules are exposures to Saudi government, SAMA and entities connected with Saudi Government, GCC and OECD central governments and their central banks, intra-group and intraday interbank exposures which are exempted to the extent specified under Section 4.6 of these Rules

3. Maximum Exposure Limits:

3.1. Exposure Limits:

All banks are required to ensure compliance of the following exposure limits:

i. Single Counterparty: Single counterparty: The sum of all exposures values a bank has to a single non-bank counterparty (excluding individuals and sole proprietorships) must not be higher than 15% of the banks available eligible capital base at all times. However, the banks will regularize their existing exposures to meet this requirement within the following transition period:

Effective From:	Existing Exposure to be reduced to:
1st January 2016	23% of eligible capital base
1st January 2017	21% of eligible capital base
1st January 2018	18% of eligible capital base
1st January 2019	15% of eligible capital base

ii. Group of Connected Counterparties: The sum of all exposures values a bank has to a group pf connected non-bank counterparties must not be higher than 15% of the banks available eligible capital base at all times. Where an individual/sole proprietorship/partnership is included within a Group pf Connected Counterparties, the exposure limit specified under Section 3.1 iii) below shall also be applicable, in addition to the overall group exposure limit. However, the banks will regularize their existing exposures to meet these requirements as per the transition period prescribed under Section 3.1 i) above and Section 3.1 iii) below.

Furthermore, the sum of a banks 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. However, the banks will regularize their existing exposures to meet this requirement within the following transition period;

Effective From:	Existing Exposure to be reduced to:
1st January 2016	16% of eligible capital base
1st January 2017	12% of eligible capital base
1st January 2018	8% of eligible capital base
1st January 2019	5% of eligible capital base

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, subject to the following

a. If the lending bank and the counterparty bank are both designated by SAMA as Domestically – Systemically Important Banks (D-SIBs), 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

b. If the lending bank is not a D-SIB and the counterparty bank is a D-SIB or G-SIB, 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

c. If the lending bank is a D-SIB and the counterparty bank is a G-SIB, 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. Related Counterparty: The sum of all exposures values a bank has to a non-bank related counterparty must not be higher than 10% of the bank’s available eligible capital base at all times. However, a bank may have exposure to its non-banking subsidiary in financial sector of up to 25% of the banks eligible capital. Any existing exposures in excess of this limit of 25% will be proportionately reduced by one-fourth every calendar year over the next four years so as to fully regularize the position by 31st December 2018. Furthermore, a cumulative limit on all exposures to non-bank related counterparties shall be 50% of the banks eligible capital;

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

3.2. Measurement of Exposures and Capital Base:

The exposures must be measured as specified in Section 4 of these Rules. The eligible capital base is the effective amount of Common Equity Tier 1 capital fulfilling the criteria defined in Section A of the “Finalized Guidance Document Concerning the Implementation of Basel III”.

3.3. Breaches of Limits:

Any breaches of the exposure limits, which must stay exceptional events, must be communicated immediately to SAMA and must be rapidly rectified. Furthermore, any such breaches may attract punitive supervisory action depending upon their materiality.

4. Measurement of Exposures Values:

4.1. 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. 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 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.

4.2. 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 protection and financial collateral that qualify as eligible financial collateral under the standardised approach for risk-based capital requirement purposes. (Note: SAMA does not consider equities, including convertible bonds and Undertakings for Collective Investments in Transferable Securities as eligible CRM mitigants)

Other forms of collateral that are only eligible under the Internal-ratings based (IRB) approach in accordance with paragraph 289 of the Basel II text (receivables, commercial and residential real estate and other collateral) are not eligible to reduce exposure values for large exposures purposes.

A bank must recognize an eligible CRM technique in the calculation of an exposure whenever it has used this technique to calculate the risk-based capital requirements, and provided it meets the conditions for recognition under the large exposures framework:

i. Treatment of maturity mismatches in CRM

a. In accordance with provisions set out in the risk-based capital framework, hedges with maturity mismatches are recognised only when their original maturities are equal to or greater than one year and the residual maturity of a hedge is not less than three months.

b. If there is a maturity mismatch in respect of credit risk mitigants (collateral, on-balance sheet netting, guarantees and credit derivatives) recognised in the risk-based capital requirement, the adjustment of the credit protection for the purpose of calculating large exposures is determined using the same approach as in the risk-based capital requirement.

ii. On-balance sheet netting

a. Where a bank has in place legally enforceable netting arrangements for loans and deposits, it may calculate the exposure values for large exposures purposes according to the calculation it uses for capital requirements purposes – i.e. on the basis of net credit exposures subject to the conditions set out in the approach to on-balance sheet netting in the risk-based capital requirement.

4.3. Recognition of CRM techniques in reduction of original exposure

A bank must reduce the value of the exposure to the original counterparty by the amount of the eligible CRM technique recognised for risk-based capital requirements purposes. This recognised amount is:

• the value of the protected portion in the case of unfunded credit protection;
• the value of the portion of claim collateralised by the market value of the recognised financial collateral when the bank uses the simple approach for risk-based capital requirements purposes;
• the value of the collateral adjusted after applying the required haircuts, in the case of financial collateral when the bank applies the comprehensive approach. The haircuts used to reduce the collateral amount are the supervisory haircuts under the comprehensive approach. Internally modelled haircuts must not be used.

4.4. Recognition of exposures to CRM providers

Whenever a bank is required to recognise a reduction of the exposure to the original counterparty due to an eligible CRM technique, it must also recognise an exposure to the CRM provider. The amount assigned to the CRM provider is the amount by which the exposure to the original counterparty is reduced (except in the cases where credit protection takes the form of a CDS and either the CDS provider or the referenced entity is not a financial entity, since in these cases the amount assigned is the counterparty credit risk exposure value calculated according to the SA-CCR).

4.5. Treatment of Specific Measurement Issues:

While determining the exposure values for the purposes of these Rules, the following specific issues will be dealt with as per the guidance provided in the BCBS Document titled “Supervisory Framework for measuring and controlling large exposures” issued in April 2014 (available at https://www.bis.org/pub/bcbs283.pdf) and FAQs (available at https://www.bis.org/bcbs/pub/d384.pdf) issued in Sept 2016

i) Definition of exposure values:

a. Banking book on-balance sheet non-derivative assets;

b. Banking book and trading book OTC derivatives (and any other instrument with counterparty credit risk);

c. Securities financing transactions;

d. Banking book “traditional” off balance sheet commitments;

ii) Trading Book Positions:

a. Calculation of exposure value for trading book positions;

b. Offsetting long and short positions in the trading book;

iii) Covered bonds (only if such bonds are issues in any of the GCC or OECD countries)

iv) Collective investment undertakings, securitizations vehicles and other structures;

v) Exposures to central counterparties

4.6. Exposures Exempted from Exposure Limits:

The following exposures shall be exempt from the large exposure limits specified under these Rules:

i. Sovereign exposures and entities connected with the Saudi Government: Banks’ exposures to the Saudi Government, SAMA, Entities Connected with the Saudi Government, GCC and OECD central governments and their central banks will be exempt from exposure limits as under:

a. Any exposure directly taken to Saudi Government, SAMA and any of the Entities Connected with the Saudi Government;

b. Any portion of an exposure guaranteed, or secured by the financial instruments issued by Saudi government or SAMA;

c. Any exposure to the GCC and OECD central governments and their central banks;

d. Any entity falling within the scope of the above sovereign exemption will not be taken into account when determining whether two (or more) entities that are in scope must be connected to form a Group of Connected Counterparties (i.e. if two entities that are in scope of the framework, which are otherwise not connected, are controlled by or economically through an exempted entity they need not be connected);

e. Any exposure to an exempted entity which is hedged by a credit derivative, will be recognized as an exposure to the counterparty providing the credit protection notwithstanding the fact that the original exposure is exempted;

f. All exposures that are subject to the sovereign exemption under this Section must be reported under the regulatory reporting requirements if these exposures meet the minimum reporting threshold.

ii. Interbank exposures: All intra-day interbank exposures will not be subject to the large exposures limits, neither for reporting purposes nor for application of the large exposure limits. However, all non-intraday interbank exposures will be subject to the large exposure limits.

In addition, under stressed circumstances, SAMA (under its discretion) may accept a breach of an interbank limit ex post, in order to help ensure stability in the interbank market;

iii. Intra-group exposures: All exposures to intra-group entities of the concerned bank will not be subject to the large exposures limits provided that such entities are included in the scope of accounting consolidation of the banking group. However, the non-banking subsidiaries in the financial sector will be subject to the exposure limit of 25% of the banks eligible capital as specified under Section 3.1(v) of these Rules.

All other exposures of a bank, not specifically listed above as exempted, including covered bonds issued in any of the countries other than GCC and OECD countries, must be fully subject to the large exposure limits.

5. Exposure to Related Counterparties:

Banks shall ensure compliance of the following requirements while taking any exposure to related parties:

i. Exposures to related parties shall only be considered on arm’s length basis and without any preferential treatment. Furthermore, any such credit exposures should also be strictly in line with the bank’s credit policy and procedures;

ii. Any exposure to a related party should be approved at the level of Board of Directors. While considering any proposal of lending to a Board member or any of his connected party, the Board of Directors shall ensure that the concerned Board member would neither participate in the discussion nor influence such a decision;

iii. Banks should institute procedures to prevent the beneficiaries of any credit exposure being part of the processing or approval of such exposure;

iv. Any facilities granted by a bank to its key executives/members of senior management as a part of their employment contract/compensation package shall be exempt from the application of these rules.

6. Additional Requirements:

While ensuring compliance with the exposure limits under these Rules, the banks shall also meet the following additional requirements:

i. The exposure limits under these Rules shall be calculated based on the eligible capital base as disclosed in the latest published quarterly financial statements of the bank;

ii. The exposure limits specified under these Rules are the maximum and within such limits, each bank can set lower exposure limits as a part of its Credit Policy. Banks are required to introduce adequate internal systems and controls to closely monitor on daily basis all large exposures and ensure compliance with the specified limits;

iii. Banks shall include appropriate clauses in their respective credit Policies on the management and control of large exposures;

iv. For the purpose of compliance with exposure limits under these Rules, banks shall measure, monitor, and report all exposures net of amounts reduced by eligible CRM techniques.

7. Regulatory Reporting:

Banks are required to submit to SAMA the following information on their exposures before and after application of the credit risk mitigation techniques, on quarterly basis:

i) All Large Exposures as defined in the BCBS “Supervisory Framework for measuring and controlling large exposures” issued in April 2014 (before application of the credit risk mitigation techniques) along-with the ratio of the aggregate of all such large exposures with the banks eligible capital, on the prescribed format attached as Appendix-I;

ii) All Large Exposures (after application of the credit risk mitigation techniques) along-with the ratio of the aggregate of all such large exposures with the banks eligible capital, on the prescribed format attached as Appendix-II;

iii) All the exempted exposures with values equal to or above 10% of the banks eligible capital, on the prescribed format attached as per Appendix-I & II;

iv) Their largest 50 exposures to counterparties, irrespective of the values of these exposures relative to the banks eligible capital base, on the prescribed format attached as per Appendix-III;

v) All exposures that exceeded the exposure limits specified under these Rules during the reporting quarter even if regularized subsequently, on the prescribed format attached as per Appendix-IV;

vi) All exposures to related counterparties that exceeded 5% of the banks eligible capital base on the reporting date, on the prescribed format attached as per Appendix-V.

The above information shall be submitted to the Authority starting from the quarter ending 30th September, 2015 and each calendar quarter thereafter, within 30 calendar days of the end of each quarter.

8. Implementation:

All banks are required to institute necessary policies and procedures to ensure compliance of these Rules. SAMA will monitor compliance of these Rules through its off-site monitoring and on-site inspection process.

9. Sanctions

Where an offence has occurred, SAMA can impose any one or more of the sanctions stipulated in Article (22) and (23) of the Banking Control Law.

10. Effective Date

These revised Rules shall come into force with effect from 1st July 2015. Banks are required to ensure compliance of these Rules while taking any new exposure or