Banks Act, 1990 (Act No. 94 of 1990) Regulations Regulations relating to Banks Chapter II : Financial, Risk-based and other related Returns and Instructions, Directives and Interpretations relating to the completion thereof 23. Credit risk: monthly return Directives and interpretations for completion of monthly return concerning credit risk (Form BA 200) Subregulation (9) Credit risk mitigation: standardised approach

 

 

When a bank that adopted the standardised approach for the measurement of its exposure to credit risk in its banking book obtains eligible collateral, guarantees or credit-derivative instruments, or enters into a netting agreement with a client that maintains both debit and credit balances with the reporting bank, a reduction in

the credit risk exposure of the reporting bank shall be allowed to the extent that the bank achieves an effective and verifiable transfer of risk.

 

No transaction in respect of which the reporting bank obtained credit protection shall be assigned a risk weight higher than the risk weight that applies to a similar transaction in respect of which no credit protection was obtained.

 

 

When a bank entered into a netting agreement in respect of loans and deposits as envisaged in subregulation (7)(a) above, the bank—

provided that the bank shall at all times comply with the relevant conditions specified in subregulation (7)(a) above.

 

 

provided that—

 

 

A bank that adopted the standardised approach for the measurement of its exposure to credit risk shall in addition to the requirements specified in this subregulation (9), comply with all the relevant requirements and conditions relating to eligible collateral specified in subregulation (7)(b).

 

 

For risk mitigation purposes, the instruments specified below shall be regarded as eligible collateral in terms of the simple approach, provided that, irrespective of its credit rating, a resecuritisation instrument shall in no case constitute an eligible instrument for risk mitigation purposes in terms of these Regulations.

 

 

When cash on deposit, certificates of deposit or comparable instruments issued by the lending bank are held as collateral at a third-party bank in a non-custodial arrangement, the bank may assign the risk weight related to the third party bank to the exposure amount protected by the collateral provided that the cash/instruments are pledged/assigned to the lending bank, the pledge/assignment is unconditional and irrevocable, and the bank has applied the relevant haircut specified below in respect of currency risk.

 

 

 

 

including all senior instruments issued by a bank that is rated at least BBB- or A-3/P-3 and the reporting bank has no information that suggests a lower rating in respect of the said senior instrument.

 

Provided that when the Registrar is of the opinion that the instruments are no longer sufficiently liquid, the Registrar may determine that the aforesaid instruments no longer qualify as eligible collateral.

 

 

 

 

 

 

 

in respect of all collateral instruments that do not otherwise than in accordance with this item (B) qualify as eligible collateral.

 

 

In respect of both the simple approach and the comprehensive approach for the recognition of risk mitigation, when a bank obtained collateral of which the value is less than the amount of the bank's exposure to credit risk, the bank shall recognise the credit protection on a proportional basis, that is, the protected portion of the exposure shall be risk weighted in accordance with the relevant provisions of this paragraph (b) and the remainder of the credit exposure shall be regarded as unsecured.

 

 

A bank that adopted the simple approach relating to credit risk mitigation shall risk weight its exposures in accordance with, and comply with, the relevant requirements specified in subregulation (7)(b).

 

 

A bank that obtained eligible financial collateral and that adopted the comprehensive approach for the measurement of the bank's protected exposure—

 

 

 

Notwithstanding the choice made between the standardised approach and the foundation IRB approach for the measurement of the bank's exposure to credit risk, a bank may choose to use the standard haircut percentages specified in table 9 in subparagraph (xi) below or the bank's own estimates of haircuts.

 

However, once a bank decided to use its own estimated haircuts, the bank shall apply its own haircuts to the full range of instrument types for which the bank obtained approval to use own estimates, except in the case of immaterial portfolios when the bank may use the standard haircuts prescribed in table 11 in subparagraph (xi) below.

 

 

 

A bank—

 

[Words preceding formula substituted by section 3(f) of Notice No. 1427, GG44048, dated 31 December 2020 - effective 1 January 2021]

 

E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]).

 

where:

 

 

 

 

 

 

 

The haircut that relates to currency risk shall be 8 per cent, based on a ten business day holding period and daily mark-to-market.

 

 

 

A bank that applies the standard haircuts specified in subparagraph (xi) below, or its own estimated haircuts, which bank wishes to recognise the effects of bilateral master netting agreements, shall calculate its adjusted exposure through the application of the formula specified below, provided that the bank shall comply with the minimum requirements relating to bilateral netting agreements specified in subparagraph (xvi) below. The formula is expressed as:

 

E* = max {0, [(Σ(E) - Σ(C)) + Σ ( Es x Hs) + Σ (Efx x Hfx)]}

 

where:

 

 

 

 

 

 

 

 

The haircut that relates to currency risk shall be 8 per cent, based on a ten business day holding period and daily mark-to-market.

 

 

A bank that uses a VaR model approach to reflect the price volatility of the exposure and the collateral shall calculate its adjusted exposure through the application of the formula specified below:

 

E* = max {0, [(Σ E - Σ C) + VaR output from the internal model]}

 

where:

 

 

 

 

 

 

Table 9: Standard haircut1

 

When a bank obtained collateral that consists of a basket of instruments, the haircut in respect of the basket of instruments shall be calculated in accordance with the formula specified below, which formula is designed to weight the collateral in the basket.

 

H = Σ ai Hi

 

where:

 

ai        is the relevant weight of the asset, measured in terms of the relevant currency units, in the basket

Hi        is the haircut applicable to the relevant asset

 

 

As a minimum, a bank that wishes to calculate its own haircuts for purposes of calculating the bank's adjusted exposure—

 

 

 

 

 

 

When a bank uses a weighting scheme or other method for the historical observation period, the effective observation period shall be at least one year, that is, the weighted average time lag of the individual observations shall not be less than 6 months.

 

 

(G)        shall reassess the data whenever market prices are subject to material change.

 

 

As a minimum, a bank that wishes to calculate its own haircuts for purposes of calculating the bank's adjusted exposure—

 

 

 

 

 

 

 

 

Table 10

 

(B)        When—

 

 

where:

 

 

 

 

 

For example, when a bank calculates the volatility on a TN day holding period which is different from the specified minimum holding period TM, the bank shall calculate the relevant haircut HM using the square root of time formula specified below:

 

 

where:

 

 

 

 

Similarly, when the frequency of remargining or revaluation is longer than the minimum period specified in table 10 above, the relevant percentage in respect of the minimum haircut shall be scaled up depending on the actual number of business days between remargining or revaluation, using the relevant square root of time formula.

 

For example, based on the relevant specified square root of time formula, a bank that uses the standard haircuts specified in table 9 in subparagraph (xi) above shall use the relevant ten business day haircut percentages specified in the table as a basis in scaling the said haircut percentages up or down depending on the type of transaction and the frequency of remargining or revaluation, as specified below:

 

 

where:

 

 

 

 

 

 

In the case of any repo-style transaction, a bank other than a bank that obtained the approval of the Registrar to apply its VaR model to reflect price volatility as envisaged in subparagraph (xvii) below may apply a haircut of zero per cent, provided that—

 

 

A bank—

In cases of legal uncertainty, the reporting bank shall obtain a legal opinion to the effect that its right to apply netting of gross claims is legally well founded and would be enforceable in the liquidation, default or bankruptcy of the counterparty or the bank;

(bb)        the prompt liquidation or set-off of collateral upon an event of default.

 

 

As an alternative to the use of the standard haircuts specified in table 9 in subparagraph (xi) above, or the calculation of own estimated haircuts, a bank that obtained the prior written approval of the Registrar for the use of risk measures derived from the bank's internal risk-management model in respect of the bank's trading activities may use a VaR-model approach to reflect the price volatility of the exposure and the collateral in respect of repurchase or resale agreements, taking into account the effects of correlation between security positions, provided that—

 

 

As a minimum, a bank that adopted the standardised approach for risk mitigation relating to guarantees shall comply with—

 

(ii)        Eligible guarantees/guarantors

 

For risk mitigation purposes in terms of these Regulations, credit protection obtained from guarantors that are assigned a risk weight lower than the protected exposure shall be recognised as eligible guarantees, including guarantees obtained from—

Provided that—

[Proviso (ii) of regulation 23(9)(c)(ii) substituted by regulation 6(k) of Notice No. 297, GG 40002, dated 20 May 2016]

 

 

When a bank that adopted the standardised approach for risk mitigation obtains protection against loss in the form of an eligible guarantee in respect of the bank's exposure or potential exposure to credit risk, the risk weight applicable to the guaranteed transaction or guaranteed exposure may be reduced to the risk weight applicable to the relevant guarantor in accordance with the provisions of this paragraph (c).

 

The lower risk weight of the guarantor shall apply to the outstanding amount of the exposure protected by the guarantee, provided that the bank shall comply with the said relevant minimum requirements.

 

The unprotected portion of the exposure shall retain the risk weight relating to the relevant counterparty.

 

(iv)        Materiality thresholds

 

For purposes of these Regulations, a materiality threshold below which no payment will be made in the event of a loss to the reporting bank or that reduces the amount of payment by the guarantor shall be regarded as equivalent to a retained first-loss position and shall be risk weighted in accordance with the relevant provisions of subregulation (6)(j) above.

 

(v)        Proportional cover

 

When a bank obtains a guarantee for less than the amount of the bank's exposure to credit risk, the bank shall recognise the credit protection on a proportional basis, that is, the protected portion of the exposure shall be risk weighted in accordance with the relevant provisions of this paragraph (c) and the remainder of the credit exposure shall be regarded as unsecured.

 

(vi)        Currency mismatches

 

When a bank obtains credit protection that is denominated in a currency that differs from the currency in which the exposure is denominated, the amount of the exposure deemed to be protected shall be reduced by the application of the formula specified below, which formula is designed to recognise the effect of the currency mismatch. The formula is expressed as:

 

GA = G x (1 -HFx)

 

where:

 

 

 

The haircut shall be based on a ten business day holding period and daily mark to market.

 

When a bank applies the standard haircuts, a haircut equal to 8 per cent shall apply.

 

A bank shall use the relevant square root of time formula specified in paragraph (b)(xiv) above to scale up a haircut percentage when the holding period or frequency of mark-to-market adjustment differs from the specified minimum requirements.

 

 

 

 

The lower risk weight relating to the eligible protection provider shall apply to the outstanding amount of the transaction or exposure protected by the credit-derivative instrument, provided that all the  relevant conditions specified in this paragraph (d) are met.

 

The unprotected portion of the exposure shall retain the risk weight relating to the relevant underlying exposure.

 

 

(C)        In the case of—

 

 

 

A bank that is a protection buyer shall risk weight such a materiality threshold in accordance with the relevant provisions specified in subregulation (6)(j) above. The capital requirement in respect of such bought protection shall be limited to the capital requirement relating to the underlying asset or reference asset when no protection is recognised.

 

 

 

 

 

The protection provider shall risk weight the exposure according to the risk weight applicable to the reference asset or underlying asset, or the risk weight applicable to the protection buyer, whichever risk weight is the highest.

 

The exposure at risk shall be limited to the maximum payment in terms of the credit-derivative contract.

 

 

[Regulation 23(9)(d)(ii)(C) substituted by section 2(o) of Notice No. 2561, GG46996, dated 30 September 2022 - effective 1 October 2022]

 

 

 

Table 11

[Regulation 23(9)(d)(ii)(C)(i), Table 11,  substituted by regulation 6(l) of Notice No. 297, GG 40002, dated 20 May 2016]

[Regulation 23(9)(d)(C)(ii) substituted by regulation 2(h) of Notice No. R. 261, GG 38616, dated 27 March 2015]

 

 

 

 

For risk-mitigation purposes in terms of these Regulations, credit protection obtained from protection providers that are assigned a risk weight lower than the protected exposure shall be recognised as eligible protection providers, including protection obtained from:

 

Provided that—

[Proviso to regulation 23(9)(d)(iii) substituted by regulation 2(m) of Notice No. R. 297, GG 40002, dated 20 May 2016]

 

A bank may issue cash instruments, such as credit-linked notes, in respect of which instruments the repayment of the principal amount is linked to the credit standing of a reference asset, reference entity or underlying asset.

 

For risk-mitigation purposes, a bank shall treat credit-linked notes in a manner similar to cash-collateralised transactions.

 

 

 

Although the legal construction of guarantees may differ from credit-derivative instruments, only credit-default swaps and total-return swaps that provide credit protection equivalent to guarantees shall be recognised as credit risk-mitigation instruments, in addition to credit-linked notes, in terms of these Regulations.

 

 

 

 

However, the economic effect of a materiality threshold specified in a credit-derivative contract may be that the protection buyer will suffer a specified amount of loss before payment in terms of the credit-derivative contract is triggered or the amount of payment by the protection seller to the protection buyer may even be reduced.

 

Materiality thresholds specified in a credit-derivative contract may therefore result in a significant loss being incurred by the protection buyer on an underlying asset or reference asset without a credit-event payment being made.

 

 

 

 

 

 

 

 

 

 

When the payment in terms of a credit-derivative instrument is a fixed amount, that is, a binary payment, the amount of protection shall be the amount of the fixed payment.

 

 

When obligations in terms of credit-derivative instruments are physically settled, problems associated with the valuation of the reference asset, reference entity or underlying asset following a credit event are avoided.

 

 

 

A bank shall include in the forms BA 320 and BA 325 all relevant foreign-currency positions created by credit-derivative instruments when the bank calculates its aggregate effective net open foreign-currency position.

 

 

When a bank obtains credit protection for less than the amount of the  bank's exposure to credit risk, the bank shall recognise the credit protection on a proportional basis, that is, the protected portion of the exposure shall be risk weighted in accordance with the provisions of this paragraph (d) and the remainder of the credit exposure shall be regarded as unsecured.

 

 

 

 

 

Should the Financial Surveillance Department of the Reserve Bank grant its approval to the said transaction, the bank shall adhere to such rules, conditions or such regulations as may be specified by the Financial Surveillance Department of the Reserve Bank relating to such credit-derivative instruments;

 

 

 

 

A bank that wishes to recognise the risk-mitigation effect of protection obtained in the form of a credit-derivative instrument in the calculation of the bank's credit exposure shall comply with the requirements specified below:

 

 

The credit protection shall constitute a direct claim on the protection seller.

 

 

The credit protection shall be linked to specific credit exposures, so that the extent of the cover is duly defined and incontrovertible.

 

 

Other than a protection buyer's non-payment of money due in respect of the credit protection contract, there shall be no clause in the contract that would allow the protection seller unilaterally to cancel the credit protection or increase the effective cost of the protection as a result of deterioration in the credit quality of the protected exposure.

 

 

There shall be no clause in the contract other than clauses relating to procedural requirements that could prevent the protection seller from being obliged to make payment in a timely manner should a credit event occur in respect of an underlying asset, reference entity or reference asset.

 

 

In cases of uncertainty, a bank shall obtain legal opinion confirming the enforceability of the credit protection in all relevant jurisdictions and that the bank's rights are legally well founded. Legal opinions shall be updated at appropriate intervals in order to ensure continuing enforceability.

 

 

 

 

When a credit-derivative instrument is denominated in a currency that differs from the currency in which the credit exposure is denominated, that is, when there is a currency mismatch, the bought protection may be less than expected owing to fluctuations in the exchange rates.

 

When a bank obtains credit protection that is denominated in a currency that differs from the currency in which the exposure is denominated, the amount of the exposure deemed to be protected shall be reduced by the application of the formula specified below, which formula is designed to recognise the effect of the currency mismatch. The formula is expressed as:

 

GA =        G x (1 -HFX)

 

where:

 

 

 

 

The haircut shall be based on a ten business day holding period and daily mark to market.

 

When a bank applies the standard haircuts, a haircut equal to 8 per cent shall apply.

 

A bank shall use the relevant square root of time formula specified in paragraph (b)(xiv) above to scale up a haircut percentage when the holding period or frequency of mark-to-market adjustment differs from the specified minimum requirements.

 

 

While credit-derivative instruments reduce credit risk, they simultaneously increase other risks to which a bank is exposed, such as legal and operational risks.

 

Therefore, a bank shall employ robust procedures and processes to control the aforesaid risks.

 

As a minimum, a robust risk-management process relating to credit-derivative instruments shall include the fundamental elements specified below:

 

(aa)        Strategy

 

A duly articulated strategy for credit-derivative instruments shall form an intrinsic part of a bank's general credit strategy and overall liquidity strategy.

 

 

A bank shall continue to assess an exposure that is hedged by a credit-derivative instrument on the basis of the borrower's creditworthiness. A bank shall obtain and analyse sufficient financial information to determine the obligor's risk profile and its risk management and operational capabilities.

 

(cc)        Systems

 

A bank's policies and procedures shall be supported by management systems capable of tracking the location and status of its credit-derivative instruments.

 

 

A bank shall have in place a duly defined policy with respect to the amount of concentration risk that it is prepared to accept.

 

A bank shall take into account purchased credit protection when assessing the potential concentrations in its credit portfolio, including when the bank determines its concentration risk in terms of section 73 of the Act.

 

A bank shall monitor general trends affecting its credit-protection sellers, in order to mitigate its concentration risk.

 

 

When a bank obtains credit protection that differs in maturity from the underlying credit exposure, the bank shall monitor and control its roll-off risks, that is, the fact that the bank will be exposed to the full amount of the credit exposure when the credit protection expires.

 

 

When the credit-derivative instrument does not include the restructuring of the underlying obligation as a credit event, it shall be deemed that the bank obtained protection equal to a maximum of sixty per cent of the amount covered in terms of the credit-derivative instrument.

 

 

When the credit-derivative instrument does not include the restructuring of the underlying obligation as a credit event, it shall be deemed that the bank obtained protection equal to a maximum of sixty per cent of the amount covered in terms of the credit-derivative instrument.

 

 

 

 

 

 

(xviii)        Asset mismatch

 

When the reference asset and the underlying asset being hedged differ the protection buyer may suffer a loss on the underlying credit exposure that will not be fully compensated by an equivalent claim against the protection seller.

 

When there is an asset mismatch between the underlying exposure and the reference asset the protection buyer will be allowed to reduce the credit exposure provided that—

 

 

 

 

The effective maturity of the underlying exposure shall be the longest possible remaining time before the obligor is scheduled to fulfil its obligation.

 

Embedded options that may reduce the term of the credit protection shall be taken into account when the effective maturity of the credit protection is determined so that the shortest possible effective maturity is used. For example, the effective maturity of credit protection with step-up and call features will be the remaining time to the first call.

 

provided that in the calculation of its minimum required amount of capital and reserve funds a bank shall in no case recognise credit protection obtained when the residual maturity of such credit protection is less than or equal to three months.

 

 

Pa = P x (t-0.25)/(T-0.25)

 

where:

 

Pa        is the relevant value of the credit protection obtained, adjusted for the maturity mismatch

 

 

 

 

 

 

The bank may be unable to obtain further protection or to maintain its capital adequacy when the protection expires.

 

[Regulation 23(9)(e)(vi) inserted by section 2(p) of Notice No. 2561, GG46996, dated 30 September 2022 - effective 1 October 2022]

 

 

the bank shall subdivide the exposure into portions covered by the relevant types of risk mitigation instruments.

 

 

When a bank that adopted the standardised approach for the measurement of the bank's exposure to credit risk obtains protection in respect of a securitisation exposure the bank shall calculate its risk weighted exposure in respect of the said exposure in accordance with the relevant requirements specified in subregulation (7)(e) read with the relevant requirements specified in this subregulation (9).

 

 

[Regulation 23(9)(h) substituted by section 2(q) of Notice No. 2561, GG46996, dated 30 September 2022 - effective 1 October 2022]