Threshold Amounts for the Revised Standardised and IRB Credit Risk Approaches and Liquidity Framework

P O Box 427 Pretoria 0001 South Africa
370 Helen Joseph Street Pretoria 0002
+27 12 313 3911 / 0861 12 7272 www.resbank.co.za Ref.: 15/8/1/3 D8/2023 To: All banks, branches of foreign institutions, controlling companies, eligible institutions and auditors of banks or controlling companies Directive issued in terms of section 6(6) of the Banks Act 94 of 1990 Threshold amounts related to the revised standardised and internal ratings-based approaches for credit risk and the liquidity risk framework Executive summary The Prudential Authority (PA) continues to strive towards ensuring that the legislative framework for the regulation and supervision of banks and banking groups in South Africa remains relevant. Following the global financial crisis that commenced in 2007, various international standard-setting bodies agreed to put in place, among other things, comprehensive measures, policies, regulations and reforms to promote the safety and soundness of the international financial system. In this regard, the Basel Committee on Banking Supervision (BCBS) has issued various new or revised frameworks or requirements during recent years for implementation by member jurisdictions. In this regard, on 7 December 2017, the BCBS issued the revised standardised approach (STA) and internal ratings-based (IRB) approach for credit risk. In September 2022 the PA issued proposed amendments to the Regulations relating to Banks (Regulations) to incorporate the respective requirements specified in the revised STA and IRB approaches for credit risk issued by the BCBS into the Regulations. The PA subsequently issued Guidance 3 of 2023 setting out the implementation dates of the outstanding regulatory reforms in South Africa. This directive must be implemented in accordance with provisions of the finalised Regulations, as and when amended. Any reference to Regulations must be interpreted as a reference to the finalised Regulations. Among other matters, the revisions to the STA and IRB approaches include new and adjusted threshold amounts used in the classification of credit risk exposures, the calculation of the minimum required capital and reserve funds, and regulatory reporting. These threshold amounts also impact the classification of assets and liabilities in the liquidity risk and interest rate risk in the banking book (IRRBB) frameworks.

Accordingly, the purpose of this directive is to specify the appropriate threshold amounts to be used by banks, controlling companies and branches of foreign institutions (hereinafter collectively referred to as banks) when implementing the various requirements of the revised STA and IRB approaches and the liquidity risk and IRRBB frameworks. This directive replaces Directive 1 of 2016 dated 12 April 2016.

1. Introduction
   1.1 Following the global financial crisis that commenced in 2007, various standard￾setting bodies agreed to put in place, among other things, comprehensive
   measures, policies, regulations and reforms to promote financial stability as well as the safety and soundness of individual financial institutions.
   1.2 On 7 December 2017, as part of the agreed regulatory reforms, the BCBS issued
   for implementation by member jurisdictions the remaining components of the Basel III post-crisis reforms.1
   1.3 These post crisis reforms include the following:
   1.3.1. Revised STA for credit risk, which is intended to improve granularity and risk
   sensitivity of the risk-weighting scheme. It also aims to reduce mechanistic reliance on external credit ratings by introducing due diligence requirements on STA banks to incentivise rigorous internal credit risk assessments.
   1.3.2. Revised IRB approach, which is intended to reduce the undue variability of risk
   weighted assets (RWA) among IRB banks by removing the advanced IRB (AIRB) approach for certain asset classes and adopting ‘input’ parameter floors for asset classes where the IRB approaches remain available.
   1.4. The revised STA and IRB approach specify various threshold amounts to be used
   by banks in the classification of credit exposures to the various asset classes as well as in the calculation of their minimum required capital and reserve funds. Some of the threshold amounts impact the classification of assets and liabilities in the calculation of the net stable funding ratio (NSFR) and the liquidity coverage ratio (LCR) in the liquidity risk framework.
2. Directive
   2.1. Based on the aforesaid and in accordance with the provisions of section 6(6) of
   the Banks Act 94 of 1990, banks are hereby directed to comply with the respective requirements specified in paragraphs 2.2 to 11.3 below:
   2.2. Classification of credit exposures in the retail asset class
   2.2.1. Regulation 23(6)(b)(iv) and proviso (i) of regulation 23(11)(c)(iv)(A)(iii) of the
   Regulations2 specify the qualifying criteria for an exposure to be included in the retail portfolio. Among other things, the exposure must be to an individual person or small business. In addition, the aggregate amount of the said exposure, after Available online https://www.bis.org/bcbs/publ/d424.htm Despite the Regulations not being finalised at the time of publication of this Directive, this Directive must be implemented in accordance with the provisions of the finalised Regulations.

the application of the relevant credit conversion factors, but before taking into account credit risk mitigation, must be less than or equal to such an amount as may be prescribed in writing by the PA from time to time.
2.2.2. Furthermore, in terms of regulation 23(6)(b)(v)(A) of the Regulations, an
exposure to an entity, institution or person shall be regarded as a retail small and medium entity (retail SME), if the outstanding exposure is less than or equal to such an amount as may be directed in writing by the PA, and complies with such further conditions as may be directed in writing by the PA.
2.2.3. Accordingly, banks are hereby directed to classify an exposure to an entity,
institution or small business in the retail asset class, provided the aggregate amount of the said exposures is less than or equal to R12.5 million.

3. Classification of credit exposures in the retail revolving asset class
   3.1. The retail asset class includes qualifying retail revolving exposures (QRRE), with
   qualifying criteria for classifying exposures in this asset class specified in regulation 23(11)(c)(iv)(B)(ii)(dd) of the Regulations. These include among other criteria, the requirement that the exposure must be to an individual and not exceed an amount that may be prescribed by the PA.
   3.2. Accordingly, banks are hereby directed to only classify an exposure in the QRRE
   asset class if, in addition to complying with the requirements specified in regulation 23(11)(c)(iv)(B)(ii)(dd) of the Regulations, the aggregate exposure amount is less than or equal to R1.5 million.
4. Firm-size adjustment for corporate SME exposures
   4.1. Banks that are granted approval to apply the IRB approach, for the calculation of
   the minimum required capital and reserve funds for their corporate, banks and sovereign exposures, must apply the risk-weight function specified in regulation 23(11)(d)(ii)(A) of the Regulations. For corporate SME exposures specifically, the formula must be adjusted using the correlation parameter specified in regulation 23(11)(d)(ii)(C) of the Regulations.
   4.2. The adjustment will apply to an SME borrower, which would otherwise be
   categorised as a corporate exposure, but where the reported turnover or sales for the consolidated group of which the SME borrower is a member is less than such amount as may be directed in writing by the PA.
   4.3. Accordingly, for the purpose of calculating the minimum required capital and
   reserve funds for exposures to corporates SME, the firm-size adjustment will apply to entities where the reported turnover or sales for the consolidated group to which the SME borrower is a member is greater than R60 million but less than or equal to R600 million.
5. Classification of credit exposures in the corporate SME asset class
   5.1. The STA and IRB approaches consist of various asset classes for classifying
   exposures. These include the corporate SME asset class. Exposures classified in this asset class are defined in regulation 67 of the Regulations as any exposure to a corporate entity or institution where the aggregate annual turnover amount

is less than a specified amount. Exposures shall be deemed to constitute a corporate SME exposure and, as such, be reported separately.
5.2. Accordingly, for the purpose of reporting credit exposures in the relevant asset
classes of the regulatory returns, banks must classify all exposures as corporate SME exposures if the reported turnover of the corporate entity or institution is less than or equal to R600 million.
6. AIRB corporate modelling cut-off
6.1. Regulation 23(13)(d)(i)(A)(i)(cc)(i) of the Regulations states that a bank shall not
apply the AIRB approach in respect of any general corporate exposure belonging to a group of persons, entities or institutions of which the total consolidated annual revenues reported in the group audited financial statements exceed such amount as may be directed in writing by the PA.
6.2. Accordingly, for the purpose of calculating the minimum required capital and
reserve funds for their exposures to corporate exposures, a bank shall not apply the AIRB approach in respect of any general corporate exposure to a person, entity or institution belonging to group of persons, entities or institutions of which the total consolidated revenues reported in the group audited annual financial statements exceed R15 billion.
7. Asset value correlation factor
7.1. Banks with approval to use the IRB approach to calculate their risk weights for
their credit exposures, must in the case of corporate institutions, sovereigns or banks apply the risk-weight function specified in regulation 23(11)(d)(ii)(A) of the Regulations.
7.2. The risk-weight function has several inputs, including a correlation parameter,
which is calculated through the application of a formula also specified in regulation 23(11)(d)(ii)(A) of the Regulations. In relation to a financial institution with total assets greater than or equal to such amount as may be directed in writing by the PA, the bank is required to apply a 1.25 multiplication factor to the specified correlation parameter.
7.3. Accordingly, for the purpose of using the risk-weight function specified in
regulation 23(11)(d)(ii)(A) of the Regulations, IRB banks must apply a multiplication factor of 1.25 to all exposures to financial institutions, provided the total assets of the said financial institution are greater than or equal to R1.2 trillion.
8. Calculation of the effective maturity
8.1. The effective maturity parameter is another input into the risk-weight function
used by banks that adopted the IRB approach for the measurement of their exposure to credit risk. For banks using the foundation IRB (FIRB) approach, regulation 23(11)(d)(ii) of the Regulations sets this parameter at 2.5 years, unless the exposure relates to a repurchase or resale transaction, in which case an effective maturity equal to six months shall apply.

8.2. For banks with approval to apply the AIRB approach, this effective maturity is
calculated in accordance with the relevant requirements of regulation 23(13)(d)(ii)(B) of the Regulations.
8.3. Moreover, in terms of regulation 23(11)(d)(A) the PA may exempt exposures
under the FIRB approach from the 2.5 years effective maturity, and instead require banks to calculate the effective maturity of these exposures in accordance with the relevant requirements specified in regulation 23(13)(d)(ii)(B).
8.4. Accordingly, banks that adopted the FIRB approach for the measurement of their
exposures to credit risk are hereby directed to calculate the effective maturity of these exposures in accordance with the requirements of regulation 23(13)(d)(ii)(B).
9. Securitisation scheme with early amortisation features
9.1. Regulation 23(6)(h)(xi)(G) of the Regulations specifies that in the case of a
securitisation scheme with early amortisation features, retail exposure means any exposure to a person of less than an amount that may be prescribed by the PA.
9.2. Accordingly, in the case of a securitisation scheme with early amortisation
features, the bank interprets retail exposure to mean any exposure to a person of less than R12.5 million.
10. Classification of funding for calculating the LCR and NSFR
10.1. Proviso (i) of regulation 26(12)(d)(iv) of the Regulations specifies that unsecured
wholesale funding provided by non-financial small business customers shall only include small business customers in respect of which the total aggregate amount of funding raised from a customer and its relevant associates or affiliates, on a gross consolidated basis, is less than such an amount as may be prescribed in writing by the PA from time to time.
10.2. Accordingly, unsecured wholesale funding provided by non-financial small
business customers shall only include small business customers in respect of which the total aggregate amount of funding raised from a customer and its relevant associates or affiliates, on a gross consolidated basis, is less than R12.5 million.
11. Classification of assets and liabilities in the IRRBB framework
11.1. Regulation 30(5)(c)(v) of the Regulations, requires a bank to distinguish between
categories or types of deposit, based upon the nature of the deposit and the depositor. More specifically, a bank shall distinguish broadly between retail and wholesale deposits.
11.2. In terms of regulation 30(5)(c)(v)(A)(i)(aa) of the Regulations, a bank may regard
any deposits made by small business customers and managed by the bank as retail exposures and as having interest rate risk characteristics similar to retail accounts. These deposits may then be treated as retail deposits, provided that the total aggregated liabilities raised from the business customer amount to less than such amount as may be directed in writing by the PA from time to time.

11.3. Accordingly, a bank shall classify and treat any deposits made by small business
customers as retail deposits, provided that the aggregate liabilities raised from the small business customer amount to less than R12.5 million.
12. Effective date
12.1. The respective requirements specified in this directive shall be effective from the
proposed implementation dates specified in Guidance Note 3/2023 and any other subsequent guidance note which may replace Guidance Note 3/2023.
13. Acknowledgement of receipt
13.1. Kindly ensure that a copy of this directive is made available to your institution’s
external auditors. In addition, the attached acknowledgement of receipt, duly completed and signed by both the Chief Executive Officer of the institution and the said auditors, should be returned to the PA at the earliest convenience of the signatories. Fundi Tshazibana Chief Executive Officer Date:
The previous directive issued was Directive 7/2023, dated 29 August 2023.