CP-1

Guidelines on
Regulatory capital
under Basel III
CP-1: Guidelines on regulatory capital under Basel III

Table of Contents
Subject Page
number
Part A- Overview 3
 Introduction 3
 Applicability 4
 Level of application 4
Part B- General requirements 5
 Capital adequacy ratios 5
 Minimum Capital adequacy requirements 5
 Capital buffer requirements 6
Part C- Components of capital 7
 Common equity tier 1 (CET1) 7
 CET1 of branches of foreign banks 7
 Additional Tier 1 capital (AT1) 8
 AT1 of branches of foreign banks 8
 Tier 2 capital 8
 Tier 2 capital of branches of foreign banks 9
Part D- Criteria for inclusion in capital 10
 Common/Ordinary shares 10
 Additional Tier 1 capital instruments 12
 Tier 2 capital instruments 15
 Minority interest and capital instruments issued 17
out of consolidated subsidiaries
o Common shares 17
o Tier 1 qualifying capital 18
o Tier 1 and Tier 2 qualifying capital 19
Part E- Regulatory adjustments 20
 Goodwill & other intangibles 20
 Deferred Tax Assets and liabilities 21
 Property revaluation gains 21
 Cumulative gains/losses on AFS financial 21
instruments
 Profit equalization reserve/Investment risk 21
reserve
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CP-1: Guidelines on regulatory capital under Basel III

 Cash flow hedge reserve 22

 Regulatory provisions for loans/financing 22
 Shortfall of eligible provisions for expected 22
losses
 Gain on sale related to securitisation 22
transaction
 Cumulative gains/losses due to changes in own 22
credit risk on fair valued liabilities
 Defined benefit pension fund assets and 22
liabilities
 Investments in own capital instruments and 23
reciprocal cross holdings
 Investments in the capital of unconsolidated 24
banking, financial/takaful/ insurance entities
 Changes to risk weighted assets calculation for 28
items formerly deducted from capital
Other requirements 28
 Minimum capital conservation ratios 28
 Requirements to ensure loss absorbency at the 29
point of non-viability
 Write off or conversion mechanisms for 31
achieving principal loss absorbency at the
point of non -viability
 Disclosure requirements 32
 Regulatory process and submission 32
requirements
Part F- Transitional arrangements 33
 Capital buffer requirements 33
 Capital instruments that no longer qualify as 34
non-common equity tier 1 or tier 2 capital
 Minority interest and capital instruments issued 37
out of subsidiaries, held by third parties and
regulatory filters
Annex 1: Illustrative example on minority interest 38
and capital instruments issued out of consolidated
subsidiaries held by third parties
Annex 2: Example of 15% common equity limit on 41
specified items

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CP-1: Guidelines on regulatory capital under Basel III

Guidelines on regulatory capital under Basel III

PART A
OVERVIEW

1. Introduction

1.1. Regulatory capital requirements seek to ensure that risk exposures of a bank
are backed by an adequate amount of high quality capital which absorbs losses on
a going concern basis. This ensures the continuing ability of a bank to meet its
obligations as they fall due while also maintaining the confidence of customers,
depositors, creditors and other stakeholders in their dealings with the institution.
Better definition of Capital requirements, with emphasis on quality, consistency,
transparency and scope for support also seeks to further protect depositors and
other senior creditors in a gone concern situation by promoting an additional
cushion of other permissible non-core capital instruments that can be used to meet
claims in the event of liquidation.

1.2 The Basel Committee on Banking Supervision (BCBS) first issued measures to
strengthen the Basel II accord in 2009 (popularly known as Basel 2.5) and then
issued a regulatory framework for increasing the resilience of banks and the
banking system in December 2010, which was revised in June 2011.This
framework is called Basel III. The Committee‟s comprehensive package was a
response to the lessons learnt from the economic and financial crisis which began
in 2007. The Basel III document was reviewed by Central Bank of Oman (CBO)
and it was decided to implement the same after due deliberation. The roadmap for
its implementation was decided in consultation with all stakeholders. The roadmap
had indicated that a concept paper on regulatory capital will be brought out by
CBO.

1.3. This document, being the said concept paper, has been prepared based
largely on „Basel III: A global regulatory framework for more resilient banks and
banking systems‟ (Basel III guidelines), Guidelines on Basel II (circular no. BM-
1009 dated September 13, 2006), the roadmap for implementation of Basel III
(circular no. BM-1024 dated August 12, 2012) and the Islamic Banking Regulatory
Framework (IBRF) released by CBO (circular no. IB-1 dated December 18,
2012).The draft document was issued for industry consultations in June 2013, and
has been finalized after duly considering all the inputs received. BM 1009 will

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CP-1: Guidelines on regulatory capital under Basel III

provide guidance on aspects not modified here in. Banks should however note to
be guided by the Basel III guidelines in approach and spirit, with particular
reference to the robustness of Tier 1and Tier 2 additional capital components
issued to third parties and should reckon all the dimensions in their ICAAP and
related initiatives.

2. Applicability
2.1. The instructions contained herein are applicable to all banks licensed under
the Banking Law 2000, including specialized banks and full -fledged Islamic Banks.
These institutions are hereafter referred to as “bank/banks”.

2.2 The terms “Central Bank” and “CBO”, wherever used in this document, means
the Central Bank of Oman.

3. Level of application

3.1. A bank is required to comply with the capital adequacy requirements based on
the instructions contained in BM -1009 or Capital Adequacy title of IBRF for Islamic
Banks, as applicable, at the following levels:

i. The global operations of the bank (i.e. including its overseas branch
operations) on a stand-alone basis, and
ii. Consolidated level, which includes entities covered under the entity level
requirement, and the consolidation of all subsidiaries. Investments in
capital of banking, insurance and takaful subsidiaries outside the scope
of regulatory consolidation require regulatory adjustments to be made as
indicated in paragraph no. 14.13.
iii. Local operations of branches of foreign banks operating in the Sultanate
of Oman

3.2. Where consolidation of other entities required under paragraph 3.1(ii) is not
feasible, banks may seek the CBO‟s approval for calculating CET 1, providing full
details of the case. Separate treatment may be prescribed by CBO for financial
and non-financial entities in such a case.

3.3 Multinational banks should follow the more stringent of the home or host
country regulations, while complying with the guidelines.

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CP-1: Guidelines on regulatory capital under Basel III

PART B
GENERAL REQUIREMENTS

4. Capital adequacy ratios

4.1. A bank shall calculate its Common Equity Tier 1 (CET1), Tier 1 and Total
Capital Ratios in the following manner:

i. CET1 Capital Ratio = Common Equity Tier 1 Capital/ Total RWA

ii. Tier 1 Capital Ratio= Tier 1 Capital/ Total RWA
iii. Total Capital Ratio = Total Capital/ Total RWA

4.2. Tier 1 Capital shall be the sum of CET1 Capital and Additional Tier 1 Capital
(AT1)
Total Capital shall be the sum of Tier 1 Capital and Tier 2 Capital

4.3. The denominator, viz., Total risk-weighted assets (RWA) shall be calculated
as the sum of credit risk weighted assets, market risk-weighted assets, and
operational risk-weighted assets, as provided for in BM-1009 and IB-1 or as
advised by CBO from time to time.

In the case of Islamic banks, the above components shall be further adjusted in the
manner stipulated under Article 2.3.1 of title 5 of IBRF relating to Capital adequacy,
unless otherwise indicated by CBO.

5. Minimum capital adequacy requirements

5.1. Basel III has recommended that the predominant form of capital shall be Tier 1
capital of which CET1 will be the predominant component. Accordingly, based on
the presently prescribed level of capital adequacy, banks operating in the
Sultanate will be required to maintain at all times, the following minimum capital
adequacy ratios:

Common equity Capital Ratio: 7% of risk weighted assets

Tier 1 Capital Ratio : 9% of risk weighted assets (Going concern capital)
Total Capital Ratio : 12% of risk weighted assets (Gone concern capital)

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5.2. Thus, within the minimum Tier I ratio of 9%, Additional CET1 items (please
see paragraph no. 8), will be admitted upto a maximum of 2% of Risk Weighted
Assets of the bank. Further, within the minimum overall capital of 12%, Tier 2
capital will be admitted upto a maximum of 3% of Risk Weighted Assets of the
bank.

6. Capital Buffer requirements

6.1. Additional capital buffers to be held by the banks above the minimum CET1,
Tier 1 and Total Capital adequacy levels have also been prescribed. These buffers
are intended to encourage the build -up of capital buffers by individual banks
during normal times that can be drawn down during stress periods. The
Countercyclical Capital Buffer is intended to protect the banking sector as a whole
from systemic risk that is often developed during an economic upswing, when
there is a tendency towards excessive aggregate credit growth. These buffers,
collectively referred to as the Buffer Requirements, comprise of:

i. a Capital Conservation Buffer (CCB),which shall be 2.5% of total RWA;

and
ii. a Countercyclical Capital Buffer (CCyB), which will lie between 0% and
2.5% of total RWA. In case other jurisdictions in which the bank has
exposures have levied differing CCyBs, then the CCyB at the
consolidated level will have to be maintained as the weighted average of
the CCyBs in all the jurisdictions, which shall however, not be less than
the CCyB prescribed by CBO.

Assuming a zero countercyclical capital buffer, banks shall operate above CET1,
Tier 1 and Total Capital levels of 9.5%, 11.5% and 14.5% respectively.

6.2. The capital conservation buffer will be implemented from January 1, 2014 and
will take full effect by January 1, 2017. The capital buffer requirements applicable
before 2017 are set forth in paragraphs on transitional arrangements. It may be
noted that banks falling short in maintaining the Capital Conservation Buffer at
prescribed levels would need to make good the shortfall at the earliest and would
face restrictions on dividend payouts and the like, to promote capital conservation.

Note: CBO plans to circulate a concept paper by 2014 providing further guidance
on how the Capital Conservation Buffer and Countercyclical Capital Buffer
requirements would be operationalised.

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CP-1: Guidelines on regulatory capital under Basel III

6.3 Notwithstanding what is stated above, the Central Bank may at its discretion,
prescribe higher loss absorbency requirements for a bank, based on its risk profile
or systemic importance.

PART C

COMPONENTS OF CAPITAL

7. Common Equity Tier 1 Capital

7.1. Common Equity Tier 1 (CET1) Capital will consist of the following elements:
i. common shares issued by the bank that meet the criteria specified in
paragraph on common shares;
ii. share premium resulting from the issue of common shares;
iii. retained earnings net of any interim losses and net of any interim and/or
final dividend proposed/declared (It is clarified that, a proposed dividend
is to be deducted upon receiving approval of the CBO).
iv. other disclosed reserves
v. qualifying minority interest (i.e. CET1 capital instruments issued by
consolidated subsidiaries of the bank held by third parties.) as
determined under paragraph 13 on minority interest
vi. Less regulatory adjustments applied in the calculation of CET1 Capital,
as determined in Part E.

7.2 Common equity Tier 1 for branches of foreign banks operating in the
Sultanate
The CET 1 will comprise of the following components:-
A) Interest free funds received from HO, maintained in Oman books, for
meeting the minimum capital requirements
B) Capital deposit funds maintained with CBO
C) Non-repatriated surplus retained in Oman books (available on long term
basis)
D) Less regulatory adjustments/deductions, as applicable to computing of
CET1.

The net credit balance in inter office head office account, being short term in
nature, would not be reckoned towards CET1. The debit balance in Head Office
account should also be temporary in nature and reflect non-capital transactions; it
should not be utilized inappropriately to move assigned capital out of the country.

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8. Additional Tier 1 Capital

8.1. Additional Tier 1 Capital shall consist of the following:
i. Capital instruments issued by the bank that meet the criteria
specified in paragraph 11 on additional tier 1 capital, and are not included in
CET1 Capital;
ii. share premium resulting from the issue of Additional Tier I
instruments
iii. qualifying Additional Tier 1 capital instruments issued by consolidated
subsidiaries of the bank held by third parties, as determined under
paragraph 13 on minority interest and which are not included in Common
Equity Tier 1;
iv. Less regulatory adjustments applied in the calculation of Additional
Tier 1 Capital, as indicated in Part E.

8.2 The additional Tier I capital for foreign banks’ branches operating in
Oman would comprise of:-
(i) Head office borrowings, complying with regulatory requirements, meant
specifically for inclusion in Additional Tier I capital;
(ii) Any other item that may be specifically allowed by CBO from time to time
Less any regulatory adjustments/deductions (please see Part E).

9. Tier 2 Capital

9.1. Tier 2 Capital shall consist of instruments that meet the following eligibility
criteria:

i. Capital instruments issued by the bank that fulfill the criteria specified in
paragraph 12 on Tier 2 capital instruments, and are not included in Tier 1 Capital;
ii. share premium resulting from the issue of Tier 2 instruments
iii. qualifying capital instruments issued by consolidated subsidiaries of the
bank held by third parties, as determined under paragraph 13 on minority interest,
that meet the criteria for inclusion in Tier 2 capital and are not included in Tier 1
capital;

iv. loan/financing loss provisions as follows:

General Provisions or loan loss reserves held against future, but presently
unidentified impairments, and which are available to meet losses
materializing subsequently, subject to a maximum of 1.25% of total credit

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CP-1: Guidelines on regulatory capital under Basel III

risk weighted assets determined under the Standardised Approach for credit
risk;
v. Revaluation reserves with a haircut of 55%

vi. Profit Equalisation & Investment Risk Reserves of Islamic Banks, to the extent
permitted in Article 2.5.2.5.1 of Title 5 of IBRF dealing with Capital adequacy, or
as advised by CBO.

vii. Less regulatory adjustments applied in the calculation of Tier 2 Capital, as

indicated in Part E.

9. 2 As mentioned in paragraph 5.2, within the specified overall minimum capital,

the Tier 2 capital will be limited to 3% of Risk weighted assets of the banks. In
other words, the non-Tier 2 capital should be at least 9% of risk weighted assets.

Note
Share premium that is not eligible for inclusion in CET1 Capital will only be
permitted to be included in Additional Tier 1 Capital if the shares giving rise to the
stock surplus are permitted to be included in Additional Tier 1 Capital. Likewise,
Share premium that is not eligible for inclusion in Tier 1 Capital will only be
permitted to be included in Tier 2 Capital if the shares from which the premium has
been generated are permitted to be included in Tier 2 Capital.

Qualification requirements of instruments for being eligible for inclusion in various

tiers of the capital are given in Part D.

Tier 2 Capital for Foreign Banks’ Branches operating in Oman

Elements of Tier 2 capital in case of foreign banks‟ branches will be as under:

(i) General Provisions and Loss Reserves (as detailed in paragraph 2.5.1 (i)
above);
(ii) Head Office (HO) borrowings received as part of Tier 2 debt capital;
(iii) Revaluation reserves at a discount of 55%;
Less regulatory adjustments applied in the calculation of Tier 2 Capital, as
determined in Part E.

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PART D
CRITERIA FOR INCLUSION IN CAPITAL

10. Common/Ordinary shares

10.1. Ordinary shares can be included in CET1 capital instrument if they meet all
the following criteria:

i. they represent the most subordinated claim in liquidation of the bank;

ii. entitled to a claim on the residual assets that is proportional with its
share of issued capital, after all senior claims have been repaid in
liquidation (i.e. has an unlimited and variable claim, not a fixed or capped
claim);
iii. principal is perpetual and never repaid outside of liquidation (Except for
repurchases or other means of capital reduction arrangements allowable
under relevant law and regulations. Repayment, repurchase or reduction
of capital shall also be subject to the prior written approval of CBO).
iv. the bank does nothing to create an expectation at issuance that the
instrument will be bought back, redeemed or cancelled nor do the
statutory contractual terms provide any feature which might give rise to
such an expectation;
v. distributions are paid out of distributable items (accumulated and
realized profits as approved by CBO, so far as they have not been
previously distributed or capitalized, less accumulated losses), with the
level of distributions not in any way tied or linked to the amount paid up
at issuance and is not subject to a contractual cap, except to the extent
that the bank is unable to pay distributions that exceed the level of
distributable items;
vi. there are no circumstances under which distributions are obligatory.
Non-payment is therefore not a default event.
vii. distributions are paid only after all legal and contractual obligations have
been met and payments on more senior capital instruments have been
made. This implies that there are no precluding any preferential
distributions, including in respect of other elements classified as the
highest quality issued capital;

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viii. ordinary shares absorb the first and proportionately greatest share of
any losses as they occur (It is clarified that the requirement for a
permanent write-off feature in capital instruments as set out Part F, does
not negate this criterion being met by ordinary shares) and within the
highest quality capital, each instrument absorbs losses on a going
concern basis proportionately and pari passu with all the others;
ix. the paid-up amount is recognised as equity capital for determining
balance sheet insolvency and the paid-up amount is classified as equity
under International Financial Reporting Standards and AAOIFI as the
case may be;
x. they are directly issued and paid-up and the bank has not directly or
indirectly funded the purchase of the instrument. If a bank issues shares
as payment for the takeover of another entity, those shares also would
require prior approval of CBO to be considered as paid up;
xi. the paid-up amount is neither secured nor covered by a guarantee of the
bank or a related entity (a related entity can include a parent company, a
sister company, a subsidiary or an affiliate. A holding company will be
treated as a related entity irrespective of whether it forms part of the
consolidated banking group.) or subject to any other arrangement that
legally or economically enhances the seniority of the claim;
xii. ordinary shares are clearly and separately disclosed on the bank‟s
audited balance sheet;
xiii. the ordinary shares are only issued with the approval of the shareholders
of the bank, either given directly by shareholders or, if permitted by law,
given by the board of directors or by other persons duly authorised by
the shareholders.

10.2. In case a bank has been allowed to issue different classes of ordinary shares
with different levels of voting rights (including non-voting shares), all classes of
ordinary shares must be identical in all respects (except the level of voting rights)
in order to qualify as a CET1 capital instrument.

10.3. Neither the bank nor a related entity over which it exercises control or
significant influence can directly or indirectly purchase and own the common
shares nor can the bank directly or indirectly have financed its ownership and
purchase, failing which the regulatory adjustments as set out in paragraph 14.12
on investment in own capital instrument shall apply.

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11. Additional Tier 1 capital instruments

11.1. Additional Tier 1 capital instruments should meet the following criteria:

i. the instrument is issued and paid-up; If a bank issues shares as payment for
the takeover of another entity, those shares also would require prior approval of
CBO to be considered as paid up

ii. the instrument is subordinated to depositors, general creditors and f

subordinated debt/sukuk of the bank;

iii. the instrument is neither secured nor covered by a guarantee of the bank or
a related entity or other arrangement that legally or economically enhances the
seniority of the claim vis-à-vis depositors, general creditors and holders of other
subordinated debt/sukuk of the bank. It is further clarified that if a bank uses a SPV
to issue capital to investors and has provided any support to the SPV (e.g. by
contributing a reserve), it will be considered as a breach of this condition;

iv. the instrument is perpetual, and therefore does not have a maturity date,
step-up features or other incentives for the bank to redeem the instrument .It is
clarified that if the instrument is so structured that after the first call date the issuer
has to pay withholding taxes, it will be taken as a situation where the issuer‟s
interest payments are increasing (even if the stated interest payment to investors
does not change), and will be considered as a step up, thereby breaching this
condition;

v. the instrument may be callable at the initiative of the bank only after a
minimum of five years, subject to the following conditions:
a. the exercise of a call option must receive prior written approval of the
CBO;
b. the bank must not do anything which creates an expectation that the
call will be exercised (e.g. calling an instrument and replacing it with a more
costly instrument would lead investors to believe that bank will exercise calls
on other instruments also), and
c. the call option must not be exercised unless:
 the called instrument is replaced with capital of the same or better
quality, and the replacement of this capital is done at conditions
which are sustainable for the income capacity of the bank
(Replacement issues can be concurrent with, but not after the
instrument is called); or

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 the bank demonstrates to the satisfaction of CBO that its capital

position is and can be sustained well above the capital adequacy
requirements and capital buffer requirements, as outlined in
paragraphs 5 and 6 respectively, even after the call option is
exercised;
vi. any repayment of principal must be with prior approval of CBO and the bank
shall not assume or create market expectations that approval will be given;
vii. dividends/coupons must be paid out of distributable items (as indicated in
10.1.(v)) , and such distributions are subject to the following conditions:
a. the bank should have full discretion at all times to cancel
distributions/payments. (Features such as “dividend pushers” are therefore
not allowed. An instrument with a dividend pusher obliges the issuing bank
to make a dividend/coupon payment on the instrument if it has made a
payment on another (typically more junior) capital instrument or share.
Banks cannot also include a condition to convert an Additional Tier 1
instrument into common equity upon non-payment, as it will impede their full
discretion to cancel payments.);
b. cancellation of discretionary payments must not constitute an event
of default;
c. the bank must have full access to cancelled payments to meet
obligations as they fall due ( the term “cancel distributions/payments”
implies that these payments are extinguished. Making
payments/distributions in kind is not permitted); and
d. cancellation of distributions/payments must not impose restrictions
on the bank except in relation to distributions to ordinary shareholders;

Dividend stopper arrangements are not prohibited. However, stoppers must not
stand in the way of full discretion of the bank to cancel distributions/payments of
the instruments, nor hamper recapitalization of the bank as indicated in criterion xi
below;

vii. the instrument cannot have a credit sensitive dividend feature, that is a
dividend/coupon that is reset periodically based in whole or in part on the credit
standing of the bank or any of its affiliated entities;
viii. The instrument cannot contribute to liabilities exceeding assets if such a
balance sheet test forms part of insolvency law.

ix. the provisions governing the instrument classified as liabilities for

accounting purposes, must have principal loss absorption through either (i)
conversion to common shares at a pre specified trigger point or (ii) a write down

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mechanism which allocates losses to the instrument at a pre specified trigger point.
The pre specified trigger point shall not be lower than 7.5% of risk weighted assets.
The write down will have the following effects: (i) reduce the claim of the instrument
in liquidation; (ii) reduce the amount repaid when a call is exercised and (iii)
partially or fully reduce coupon/dividend payments on the instrument.

For Islamic banks, write off of sukuk will not be allowed and conversion mechanism
will be the only option. It is further clarified that if the underlying Islamic mode on
which the sukuk is structured is not amenable to conversion into equity, then the
instrument cannot be included as part of additional Tier I capital;

x. for Islamic banks, the instrument shall be structured using unrestricted equity-
based contracts (e.g. Musharakah , Mudarabah), in addition to meeting other
Shariah requirements

xi. the instrument cannot have any features that hinder recapitalisation, such
as provisions that require the bank to compensate investors if a new instrument is
issued at a lower price during a specified time frame;

xii. if the instrument is not issued out of a holding company or an operating

entity (i.e. an entity set up to conduct business with clients with the intention of
earning a profit in its own right, for example a special purpose vehicle), proceeds
must be immediately available without limitation to the holding company or
operating entity in a form which meets or exceeds all of the other criteria for
inclusion in Additional Tier 1 Capital.

The capital issued by the SPV should be made available only to one operating
agency or holding company of the consolidated group. A bank cannot issue a
lower quality capital to a SPV (e.g. Tier 2) and have the SPV issue higher quality
capital to third party investors and claim recognition as a higher form of capital.
Also, Tier 2 capital issued by the SPV cannot be upstreamed by investing the
proceeds in Tier 1 instruments of the operating entity or holding company. In such
cases the transactions will be classified as Tier 2 capital at the consolidated group
level;

11.2. Neither the bank nor a related entity over which it exercises control or
significant influence can directly or indirectly purchase and own the Additional Tier
1 instrument, nor can the bank directly or indirectly have financed its ownership
and purchase, failing which the regulatory adjustments as set out in paragraph
14.12 on investment in own capital instrument shall apply.

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11.3 Share premium which is not eligible for inclusion in Common Equity Tier 1,
will be allowed to be included in Additional Tier 1 capital, only if the shares that
give rise to the share premium are permitted to be included in Additional Tier 1
capital.

12. Tier 2 capital instruments

The objective of Tier 2 is to provide loss absorption on a gone- concern basis.
Based on this objective, an instrument should meet or exceed the minimum set of
criteria given below:-

12.1. Tier 2 capital will have instruments that meet all the following criteria:
i. the instrument is issued and paid-up;
ii. the instrument is subordinated to depositors and general creditors of the
bank;
iii. the instrument is neither secured nor covered by a guarantee of the bank or
a related entity or other arrangement that legally or economically enhances the
seniority of the claim vis-à-vis depositors and general creditors of the bank;
iv. the instrument has an original maturity of at least five years, and there are
no step-up features or other incentives for the bank to redeem the instrument;
v. the instrument may be callable at the initiative of the bank only after a
minimum of five years, subject to the following conditions:

a. the exercise of a call option must receive prior written approval of

CBO;
b. the bank must not do anything which creates an expectation that the
call will be exercised; and
c. the call option must not be exercised unless:
i. the called instrument is replaced with capital of the same or better
quality, and the replacement of this capital is done at conditions
which are sustainable for the income capacity of the bank. The
replacement issues can be concurrent with but not after the call
option on the instrument has been exercised.;
ii. the bank demonstrates that its capital position is well above the
capital adequacy requirements and capital buffer requirements, as
outlined in paragraphs 5 and 6 respectively, after the call option is
exercised;
(It is clarified that an option to call the instrument after 5 years but
prior to the start of the amortization period will not be viewed as an

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incentive to redeem, provided that bank does nothing to create an

expectation that the call will be exercised at this point.)
vi. the investor must have no rights to accelerate the repayment of future
scheduled payments (coupon or principal), except in bankruptcy and liquidation;
vii. the instrument cannot have a credit sensitive dividend feature, that is a
dividend/coupon that is reset periodically based in whole or in part on the credit
standing of the bank or any of its related entities;
viii. the instrument should not have been directly or indirectly purchased by the
bank or by a related entity over which the bank exercises control or significant
influence; the bank should also not have directly or indirectly funded the purchase
of the instrument.
ix. if the instrument is not issued out of an operating entity or the holding
company in the consolidated group (eg a special purpose vehicle), proceeds must
be immediately available without limitation to the operating entity or bank in a form
which meets or exceeds all of the other criteria for inclusion in Tier 2 Capital;
x. for Islamic banks, the instrument shall be structured using exchange
contracts that are asset-based (e.g. Ijarah or Murabahah), in addition to meeting
other Shariah requirements.

12.2. In the final five years of its contractual maturity, the instrument will be
gradually de-recognised from Tier 2 Capital on a straight line basis:

Years to maturity (x) Amount recognised in

Tier 2 Capital
>5 100%
>4 80%
>3 60%
>2 40%
>1 20%
≤1 0%

12.3. Neither the bank nor a related party over which it exercises control or
significant influence can directly or indirectly purchase and own the Tier 2
instrument, nor can the bank directly or indirectly have financed its ownership and
purchase, failing which the regulatory adjustments as set out in paragraph 14.12
on investment in own capital instrument shall apply.

12.4 Within the overall minimum prescribed capital of 12% (excluding CCB and
CCyB),the aggregate amount of Tier 2 instruments cannot exceed 3% of the risk
weighted assets, as mentioned in paragraph 5.2.In other words, the Tier 1 capital
will be at least 9% of the risk weighted assets.

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12.5 Share premium which is not eligible for inclusion in Tier 1, will be allowed to
be included in Tier 2 capital, only if the shares that give rise to the share premium
are permitted to be included in Tier 2 capital.
13. Minority interest and other capital instruments issued out of consolidated
subsidiaries which are held by third parties

13.1 Under Basel II, minority interest in the consolidated subsidiaries of a bank is
recognised in the consolidated capital of the group to the extent it formed part of
regulatory capital of those consolidated subsidiaries. But it was felt that while
minority interest can support the risks in the subsidiary to which it relates, it may
not be available to support risks in the group as a whole. So, under Basel III, the
portion of minority interest which supports risks in a subsidiary that is a bank will be
included in group‟s Common Equity Tier 1.

A subsidiary is an entity which is „controlled‟ (as defined in applicable accounting

standards).

It may be noted that a bank will comply with the capital adequacy requirements
both at consolidated and standalone/solo levels. Accordingly, overseas operations
of a bank through its branches will be covered at both the levels and host country
requirements will apply, if higher. W h i l e a s s e s si n g t h e
c a p it al a d e q u a c y o f a b a n k all r e g u l a t o r y
a d j u s t m e n t s i n d i c a t e d i n Part E a r e r e q u i r e d
t o b e m a d e .

Equity and other regulatory capital investments in the capital of banking,

insurance/takaful entities outside the scope of regulatory consolidation will be
a d j u st e d fr o m c o n s o li d a t e d re g u l a t o r y
c a p it al of t h e g r o u p , a s p e r t h e
t r e a t m e n t g i v e n in terms of paragraph 14.13.

13.2 Common shares issued by the consolidated subsidiaries

Minority interest (i.e. a non- controlling interest) arising from the issue of ordinary
shares by a fully consolidated subsidiary of the bank may be recognised in
common equity CET1 if (i) the ordinary shares giving rise to the minority interest, if
issued by the bank itself, meet the criteria for classification as common shares for
regulatory purposes and (ii) the subsidiary that issued the instrument, is itself a
bank. The issuing institution, to be considered as a bank, should be subject to the
same minimum prudential standards and level of supervision as a bank.

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Minority interest in a subsidiary that is a bank will be strictly excluded from the
parent bank‟s common equity if the parent bank or affiliate has entered into any
agreements or arrangements to fund directly or indirectly the minority interest in
the subsidiary through a SPV or through any other vehicle or arrangement. In other
words, i.e. treatment outlined hereafter is for genuine third party common equity
contributions to the subsidiary.

The amount of minority interest that will be recognised in consolidated common

equity shall be calculated as follows:
 total minority interest meeting the criteria (i) & (ii) minus the amount
of surplus common equity Tier 1 of the subsidiary attributable to the
minority shareholders.
 Surplus common equity Tier 1 of the subsidiary (Including associated
retained earnings, reserves and after regulatory adjustments) is
calculated as common equity tier 1 of the subsidiary minus the lower
of :-
I. minimum common equity tier 1 requirement of the
subsidiary, plus the CCB, (i.e. 9.5% of RWAs) , and
II. Portion of consolidated minimum common equity tier 1
requirement plus the CCB, relating to the subsidiary.
 The amount of surplus common equity tier 1 attributable to minority
shareholders is calculated by multiplying the Surplus common equity
Tier 1 by the percentage of common equity tier 1 held by minority
shareholders.

13.3. Tier 1 qualifying capital issued by consolidated subsidiaries

Tier 1 capital instruments issued by a fully consolidated subsidiary of the bank and
held by third parties (including amounts under paragraph 13.1) may be recognised
in consolidated Tier 1 Capital only if the instrument would, if issued by the bank,
meets the criteria for inclusion in Tier 1 Capital.
The amount of this capital that will be recognised in consolidated Tier 1 Capital is
calculated as follows:

 total tier 1 of the subsidiary issued to third parties minus the amount
of surplus Tier 1 of the subsidiary attributable to third party investors.
 Surplus Tier 1 of the subsidiary is calculated as the tier 1 of the
subsidiary minus the lower of :-
I. minimum tier 1 requirement of the subsidiary, plus the
CCB, (i.e. 11.5% of Risk Weighted Assets), and

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II. Portion of consolidated minimum tier 1 requirement plus

the CCB, relating to the subsidiary.
 The amount of surplus tier 1 attributable to third party investors is
calculated by multiplying the Surplus Tier 1 by the percentage of tier
1 held by third party investors.

The amount of Tier 1 capital that will be recognized in AT1 will exclude the
amounts recognized in CET1, under paragraph 13.2.

13.4. Tier 1 and Tier 2 qualifying capital issued by consolidated subsidiaries

Total capital instruments issued by a fully consolidated subsidiary of the bank and
held by third parties (including amounts under paragraphs 13.1 and 13.2) may be
recognised in consolidated Total Capital only if the instruments would, if issued by
the bank, meets the criteria for inclusion in l Tier 1 or Tier 2 Capital.
The amount of this capital that will be recognised in consolidated Total Capital is
calculated as follows:

 total capital instruments of the subsidiary issued to third parties

minus the amount of surplus total capital of the subsidiary attributable
to third party investors.
 Surplus total capital of the subsidiary is calculated as the total capital
of the subsidiary minus the lower of :-
I. minimum total capital requirement of the subsidiary, plus the
CCB, (i.e. 14.5% of Risk Weighted Assets) and
II. Portion of consolidated minimum total capital requirement
plus the CCB, relating to the subsidiary.
 The amount of surplus total capital attributable to third party investors
is calculated by multiplying the Surplus total capital by the
percentage of total capital held by third party investors.

The amount of this total capital that will be recognized in Tier 2 will exclude the
amounts recognized in CET1, under paragraph 13.2 and AT1, under paragraph no.
13.3.

An example illustrating the above treatment is given at Annex 1.

13.5. Capital issued to third parties out of a special purpose vehicle (SPV) may be
included in entity and consolidated level only as Additional Tier 1 or Tier 2 Capital,
and treated as if the bank had issued the capital directly to third parties, only if:

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i. the SPV is controlled and managed by the bank, and would, in

accordance with IFRS, be fully consolidated;
iii. the SPV is set up for the sole purpose of the capital issuance for the
bank and does not conduct any other business or activity;
iv. the SPV has no external creditors at any time;
v. the entire proceeds from the capital issuance through the SPV shall
be immediately available without limitation to the bank in a form which
meets or exceeds all of the criteria for inclusion in Additional Tier 1 or Tier 2
Capital, as appropriate;
vi. the provisions governing the issuance of the instruments issued by
the SPV and the bank shall substantially be the same (e.g. maturity), and
accordingly, the capital instrument issued by the SPV shall meet all the
relevant criteria for inclusion as if the bank itself were to issue the
instrument
vii. The capital will be included in the bank‟s consolidated Additional Tier
1 or Tier 2, in accordance with the treatment outlined in paragraphs 13.2
and 13.3.

For example, if an SPV issues a Tier 2 capital instrument to investors and

upstreams the proceeds by investing in a Tier 1 capital instrument issued by the
bank, the transaction will be recognised in Tier 2 Capital. In the case of capital
instruments issued by Islamic banks based on exchange contracts through an SPV
(e.g. Murabahah or Ijarah) or using any other indirect structure the contracts
between the Islamic bank and the SPV or any parties involved shall be structured
in a manner which in combination meets or exceeds the criteria for inclusion in
capital. For example, any purchase undertaking shall be designed in a manner that
does not legally or economically enhance the seniority of capital issued.

PART E

REGULATORY ADJUSTMENTS

14.1 Goodwill and other intangibles

Goodwill, including any goodwill included in the valuation of significant capital
investments in unconsolidated entities, and all other intangibles must be deducted
in the calculation of CET1 Capital. The full amount shall be deducted net of any
associated deferred tax liability that would be extinguished if the intangible asset
becomes impaired or is derecognized.

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It may be clarified that, negative goodwill shall not be added back in the calculation
of CET1 Capital.

14.2. Deferred tax assets and liabilities

Deferred tax assets (DTAs) that rely on the future profitability of the bank to be
realised shall be deducted in the calculation of CET1 Capital. DTA may be netted
with its associated deferred tax liability (DTL) only if the DTA and DTL relate to
taxes levied by the same taxation authority and offsetting is permitted by the
relevant taxation authority. DTLs permitted to be netted against DTAs shall exclude
amounts that have been netted against the deduction of goodwill, intangibles and
defined benefit pension assets.
It may be clarified that net DTLs shall not be added back in the calculation of CET1
Capital.

14.3 Property revaluation gains

The amount of cumulative unrealised gains arising from the changes in the fair
value or revaluation of bank‟s own premises is not allowed to be reckoned towards
supplementary capital instruments, as provided in paragraph 23 of BM 1009.

14.4. Cumulative gains/losses of financial instruments classified as

“available-for-sale”

The latent revaluation reserves or cumulative unrealised gains arising from the
changes in fair value of equity instruments, classified as “available-for-sale” shall
be added to Tier 2 with a haircut of 55%, provided this capital could be used to
absorb losses on a going concern basis.

The amount of cumulative unrealised losses arising from the changes in fair value
of financial instruments, including loans/financing and receivables, classified as
“available-for-sale” shall be fully deducted in the calculation of CET1 Capital.

14.5. Profit Equalisation Reserve/Investment Risk Reserve

The profit equalisation reserve and investment risk reserve attributable to Islamic
banking operations shall be adjusted from the total risk weighted assets in the
calculation of Capital adequacy ratio as indicated in article 2.3 of Title 5 of the
Islamic Banking Regulatory Framework on Capital Adequacy. As mentioned in
article 2.5.2.5.1 of the title 5 of the Islamic Banking Regulatory Framework on
Capital Adequacy, PER and IRR may be included upto a maximum of 30% of the

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risk weighted assets financed by unrestricted investment account holders, in Tier 2

capital, unless otherwise indicated by CBO.

14.6. Cash flow hedge reserve

The amount of the cumulative fair value gains on cash flow hedges is to be
excluded from the computation of capital. Positive amounts should be deducted
and negative amounts added back to CET1.

14.7 Regulatory provisions for loans/financing

The amount of shortfall in provisioning requirements attributable to loans/financing
as required in accordance with the guidelines on Classification and Impairment
Provisions outlined in BM 977 and IB-1shall be deducted in the calculation of CET1
Capital.

14.8 Shortfall of eligible provisions for expected losses

Where the bank has been allowed to adopt the Internal Ratings-Based approach
for credit risk, any shortfall of eligible provisions to expected losses shall be
deducted in the calculation of CET1 Capital. The full amount shall be deducted and
shall not be reduced by any tax effects that could be expected to occur if
provisions were to rise to the level of expected losses.

14.9. Gain on sale related to securitisation transaction

Any increase in equity capital resulting from a securitisation transaction, such as
that associated with expected future margin income resulting in a gain-on sale,
shall be deducted in the calculation of CET1 Capital.

14.10. Cumulative gains/losses due to changes in own credit risk on fair

valued liabilities

All unrealised fair value gains and losses on financial liabilities that are due to
changes in the bank‟s own credit risk shall be derecognised in the calculation of
CET1 Capital.

14.11. Defined benefit pension fund assets and liabilities

For each defined benefit pension fund that is a net asset on the balance sheet, the
asset shall be deducted in the calculation of CET1 Capital net of any associated
deferred tax liability which would be extinguished if the asset becomes impaired or
derecognised under International Financial Reporting Standards. The amount of
defined benefit pension fund liabilities, as included on the balance sheet, shall be
fully recognised in the calculation of CET1 Capital, through a reduction in reserves.

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Assets in the fund to which the bank has unrestricted and unfettered access may,
with the prior written approval of the CBO, offset the deduction. Such offsetting
assets shall be risk-weighted as if they were owned directly by the bank.

14.12 Investments in own capital instruments and reciprocal cross holdings

All direct and indirect holdings of a bank‟s own capital instruments, whether in the
trading book or the banking book, including any own capital instruments which the
bank could be contractually obliged to purchase and any other financing provided
for the purpose of purchasing own capital instruments, will be deducted in the
calculation of capital.

In applying the deductions, banks must deduct the investment from the same
component of capital for which it would qualify. Thus, banks must deduct
investments in own common shares from CET1 (unless already derecognized
under relevant accounting standards) , investments in their own Additional Tier 1
instruments from the calculation of their Additional Tier 1 capital and must deduct
investments in their own Tier 2 instruments in the calculation of their Tier 2 capital.

In instances where a bank has an indirect exposure to an own capital instrument

(e.g. through an investment in a collective investment scheme or holdings of an
index security), the bank should look through the holdings to determine their
underlying holdings of capital. If the bank finds it difficult to look through and
monitor the exact exposure through their holdings of index securities, they should
approach CBO with their conservative estimates to obtain prior approval for their
estimation. Banks should demonstrate that in no case, the actual exposure will be
higher than the estimate made if specifically/exceptionally approved.

Gross long positions may be netted against short positions in the same underlying
exposure only if the short positions involve no counterparty risk. In the case of an
index security, the bank may net a gross long position against a short position only
if it is in the same underlying index. For the purpose of discussion, the short
position used to offset the long positions may involve counterparty risk, which will
then be subject to the relevant counterparty credit risk charge in accordance with
BM 1009 and the Islamic Banking Regulatory Framework.

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As regards reciprocal cross holdings of capital, designed to artificially inflate the

banks‟ capital positions, banks will be required to fully deduct such investments in
the capital of other banks and regulated entities like FLCs and insurance
companies from the same component of capital for which it would have qualified,
as if it were issued by the bank itself.

14.13 Investments in the capital of unconsolidated banking,

financial/takaful/insurance entities outside the scope of regulatory
consolidation

U n d e r B a s e l III, t h e s e i n v e s t m e n t s h a v e
b e e n s u b j e c t e d t o strin g e n t tr e a t m e n t i n
t e r m s o f d e d u c ti o n f ro m r e s p e c ti v e ti e r s
o f r e g ul ato r y c a pita l, b e c a u s e t h e y
c o n tri b u t e t o i nt e r c o n n e c t e d n e s s . S u c h
tr e a t m e n t w ill h el p e n s u r e t h a t w h e n
c a p it al a b s o r b s a l o s s at o n e fi n a n c i a l
i n stit uti o n t hi s d o e s n o t i m m e d i a t el y
r e s ult i n t h e l o s s o f c a p it al i n t h e
in v e s t o r b a n k .

I n v e s t m e n t s i n e n titi e s t h a t a r e o u t s i d e
o f t h e s c o p e of r e g ula t o r y c o n s o li d a ti o n
r e f e r t o i n v e s t m e n t s in e n titi e s th a t h a v e
n o t b e e n c o n s o li d a t e d a t all o r h a v e n o t
b e e n c o n s o li d a t e d i n s u c h a w a y a s t o
r e s ult i n th e ir a s s e t s b ei n g i n cl u d e d i n
t h e c al c ula ti o n of c o n s o li d a t e d ri s k -
w e i g h t e d a s s e t s of t h e g r o u p.

T h e tr e a t m e n t u n d e r t w o s c e n a ri o s i s
d i s c u s s e d in t h e f oll o w i n g p a r a g r a p h s , A
& B : -

A. Bank does not own more than 10% of the issued common share capital of the
entity
Investments in the capital instruments of unconsolidated banking, financial and
insurance/takaful entities shall include:

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i. direct, indirect and synthetic holdings (e.g. subordinated debt)

of capital instruments. Banks shall look through indirect
exposures (e.g. through an investment in a collective
investment scheme or holdings of an index security) to
determine their underlying holdings of capital. Indirect holdings
are defined as exposures or part of the exposures that will
result in a loss substantially equivalent to the loss in value of
the direct holding, if the latter loses value.

ii. the net long positions in both the banking book and trading
book. Capital includes common shares and other types of
cash and synthetic capital instruments. In this regard, the
gross long position can be offset against the short position in
the same underlying exposure where the maturity of the short
position either matches the maturity of the long position or has
a residual maturity of at least one year;
iii. underwriting positions held for longer than five working days.
iv. if the capital instrument of the entity in which the bank has
invested in does not meet the criteria for inclusion in Common
Equity Tier 1, Additional Tier 1 l, or Tier 2 Capital of the bank,
the investment is to be considered as common/ ordinary
shares for the purposes of this regulatory adjustment.

With the prior written approval of the CBO and subject to conditions that may be
specified (including the period of exclusion), certain investments where these
have been made in the context of resolving or providing financial assistance to
reorganise a distressed institution, can be allowed to be temporarily excluded.

If the total of all the holdings as listed above, exceed 10% of the bank‟s common
equity (after applying all the regulatory adjustments given in Part E), then the
amount above 10% will be deducted applying the corresponding deduction
approach, as follows:-
i. aggregate amount in excess of 10% of bank‟s common equity
x common equity holdings/total capital holdings(to be deducted from
CET1)
ii. aggregate amount in excess of 10% of bank‟s common equity
x Additional Tier I capital holdings/total capital holdings(to be
deducted from Additional Tier 1)
iii. amount in excess of 10% of bank‟s common equity x Tier 2
capital holdings/total capital holdings(to be deducted from Tier 2).

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This treatment would ensure that deductions are made in proportion to the
proportion of common equity in total capital.

Instruments in trading book below the aggregate level of 10% will be risk weighted
as per market risk rules and instruments in the banking book will be risk weighted
as per standardized approach or the internal ratings based approach, as
applicable. For the purpose of risk weighting, the amount of the holdings must be
allocated on a pro-rata basis between those below and those above the threshold.

B. Significant investments, where bank owns more than 10% of the issued
common share capital of the entity which are outside the scope of regulatory
consolidation

Investments in the capital instruments of banking/financial/takaful/insurance

entities, which are outside the scope of regulatory consolidation and where the
bank‟s aggregate investment is exceeding 10% of the issuing entity‟s common
share capital, or where the entity is an affiliate of the bank, will be subject to the
regulatory adjustments indicated hereafter.

Investments other than common shares shall be fully deducted from the bank‟s
capital following the corresponding deduction method.

The corresponding deduction approach implies that the deduction shall be made
from the same tier of capital for which the capital would qualify, had it been issued
by the bank itself. If the bank does not have enough of that tier of capital, then the
shortfall will be deducted from the next higher tier of capital.

For the purposes of this section, an affiliate is defined as a company that controls
or is controlled by, or is under common control with the bank. Control of a
company is defined as (i) ownership, control or holding with power to vote 20% or
more of a class of voting shares of the company or (ii) consolidation of the
company for financial reporting purposes.

The investments as listed below will be reckoned:

i. direct, indirect and synthetic holdings of capital instruments. Banks
shall look through indirect exposures (e.g. through an investment in a

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collective investment scheme or holdings of an index security) to

determine their underlying holdings of capital.
ii. the net long positions in both the banking book and trading book.
Capital includes common shares and other types of cash and
synthetic capital instruments. In this regard, the gross long position
can be offset against the short position in the same underlying
exposure where the maturity of the short position either matches the
maturity of the long position or has a residual maturity of at least one
year;
iii. underwriting positions held for longer than five working days
iv. if the capital instrument of the entity in which the bank has invested in
does not meet the criteria for inclusion in Common Equity Tier 1,
Additional Tier 1 l, or Tier 2 Capital of the bank, the investment is to
be considered as common / ordinary shares for the purposes of this
regulatory adjustment.

14.14 It is reiterated that reciprocal cross holdings of capital instruments that are
leading to artificially inflate the capital position of a banking institution will have to
be fully deducted. Further, any shortfall in the regulatory capital requirements in the
un-consolidated entities will also be fully deducted from CET1 of the bank.

14.15 With the prior written approval of the CBO and subject to conditions that may
be specified (including the period of exclusion), certain investments where these
have been made in the context of resolving or providing financial assistance to
reorganise a distressed institution, can be allowed to be temporarily excluded.

14.16 If the investment is issued out of a regulated financial entity and not included
in regulatory capital in the relevant sector of the financial entity, it is not required to
be deducted.
The gross long positions exceeding the threshold, which are deducted from the
capital, can be excluded for the calculation of risk weighted assets.

14.17 Investments included above that are common shares will be subject to the
threshold treatment as indicated below:-

Instead of a full deduction, the following items may each receive limited recognition
when calculating Common Equity Tier 1, with recognition capped at 10% of the
bank‟s common equity (after the application of all regulatory adjustments):

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 Significant investments in the common shares of unconsolidated financial

institutions, viz., banks, insurance and other financial entities,
 mortgage servicing rights and
 DTAs arising from temporary differences.

In 2013, banks must deduct the amount by which the aggregate of the
abovementioned three items exceeds 15% of its common equity component of Tier
1 (calculated prior to the deduction of these items but after application of all other
regulatory adjustments applied in calculation of Common Equity Tier 1). The items
included in the 15% aggregate limit are subject to full disclosure.

As of January 1, 2018, the amount of the abovementioned items that remain

recognised after the application of all regulatory adjustments must not exceed 15%
of the Common equity Tier 1 capital, calculated after all regulatory adjustments.

The amount of the three items that are not deducted in the calculation of Common
Equity Tier 1 will be risk weighted at 250%.

Please see the example at Annex 2.

14.18. Changes to the risk-weighted assets calculation for items formerly

deducted from capital

The following items, deducted equally from Tier 1 & Tier 2 under the Basel II
guidelines issued by Basel committee on Banking Supervision, will be subject to a
833% risk weight:
(i) securitisation exposures currently subject to deduction, with the
exception of any increase in equity capital resulting from a securitisation
transaction which will continue to be deducted;
(ii) certain equity exposures under the PD/LGD approach determined
under the Internal Ratings-Based approach;
(iii) non-payment/delivery on non-DvP and non-PvP transactions; and
(iv) significant investments in commercial entities.

OTHER REQUIREMENTS

15.1 Minimum capital conservation ratios

The table below shows the minimum capital conservation ratios a bank must meet
at various levels of the Common Equity Tier 1 (CET1) capital ratios. For example,
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a bank with a CET1 capital ratio in the range of 7.625%-8.25% is required to

conserve 80% of its earnings (i.e. payout no more than 20% in terms of dividends,
share buybacks and discretionary bonus payments). If the bank wants to make
payments in excess of the constraints imposed by this regime, it would have the
option of raising capital equal to the amount above the constraint which it wishes to
distribute. This would be discussed with CBO as part of the capital planning
process. The Common Equity Tier 1 ratio includes amounts used to meet the 7%
minimum Common Equity Tier 1 requirement, but excludes any additional
Common Equity Tier 1 needed to meet the 9% Tier 1 and 12% Total Capital
requirements. For example, a bank with 12% CET, and no Additional Tier 1 or Tier
2 capital would meet all minimum capital requirements, but would have a zero
conservation buffer and therefore be subject to the 100% constraint on capital
distributions.

Individual bank minimum capital conservation standards

Common Equity Tier 1 Ratio Minimum Capital
Conservation ratio *

7% - 7.625% 100%
>7.625% - 8.25% 80%
>8.25% - 8.875% 60%
>8.875% - 9.5% 40%
> 9.5% 0%
*expressed as a percentage of earnings

15.2 Once the countercyclical buffer is also in force, it will be implemented through
an extension of the capital conservation buffer. Assuming the banks are subjected
to CCyB of 2.5%, the bank‟s minimum capital conservation standards will be as
under:-

Individual bank minimum capital conservation standards, when a bank is

subject to a 2.5% countercyclical requirement
Common Equity Tier 1 Ratio Minimum Capital
(including other fully Conservation
loss absorbing capital ) ratio *
7% - 8.25% 100%

>8.25% - 9.5% 80%

>9.5% - 10.75% 60%
>10.75% - 12% 40%
> 12% 0%
*expressed as a percentage of earnings

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The dividend payouts will however continue to be subject to CBO’s

discretion and approval.

15. 3 Requirements to ensure loss absorbency at the point of non-viability

The provisions governing the issuance of all non-common equity tier 1 and Tier 2
capital instrument shall contain clauses that require such instruments, at the option
of CBO, to be written-off, or the instrument to be converted into ordinary shares,
upon the occurrence of a trigger event, which shall be the earlier of the following:

i. A notification, to the bank in writing that CBO is of the opinion

that a write-off or conversion is necessary without which the
firm will become non-viable; or

ii. A decision is taken to make a public sector injection of capital,

or equivalent support, without which the firm would have
become non-viable.

The write-off or issuance of any new shares as a result of conversion or

consequent upon the trigger event must occur prior to any public sector injection of
capital. The AT1 instruments with write-off clause will be permanently written-off
when there is public sector injection of funds.

Any compensation paid to the instrument holders as a result of the write-off must
be paid immediately in the form of common stock (or its equivalent in the case of
non-joint stock companies).

The issuing bank must maintain at all times all prior authorisation necessary to
immediately issue the relevant number of shares specified in the instrument‟s
terms and conditions, should the trigger event occur. Therefore, the contractual
terms need to work within the confines of what is permissible under national
company law and the bank‟s articles of association.

15.4 The write down /conversion should generate CET1 under the relevant
accounting standards. It will receive recognition in Additional CET1, only upto the
minimum extent upto which it would generate the CET1 after conversion. The
aggregate amount to be written-down /converted for all such instruments must be
at least equal to the amount needed to immediately return the bank‟s CET1 ratio to
the trigger level, and if that is not possible then the write off/conversion should be
for the full principal value of the instrument.

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15.5 For purposes of recognising capital at the consolidated level, the provisions
governing the issuance of an Additional Tier 1 or Tier 2 capital instrument issued
by a subsidiary (apart from a banking subsidiary regulated by the Bank) and held
by third party investors shall also contain clauses that require the instrument, at the
option of the Central Bank, to be written-off, or the instrument to be converted into
ordinary shares upon the occurrence of the trigger event.

16. Write-off or conversion mechanisms for achieving principal loss

absorption and/or loss absorbency at the point of non-viability

16.1. In respect of the requirement for a capital instrument that can be written-off:
i. the write-off shall fully reduce:
a. the claim of the instrument in liquidation;
b. the amount to be re-paid when a call option is exercised; and
c. coupon or dividend payments on the instrument;
ii. the write-off shall be permanent ; and
iii. the provisions governing the issuance of the instrument must specify that a
write-off shall not constitute an event of default for that capital instrument or trigger
cross-default clauses.

16.2. In respect of the requirement for a capital instrument that can be converted
into ordinary shares:

i. the bank must maintain at all times all prior authorization necessary
to immediately issue the relevant number of shares specified in the
provisions governing the issuance of the instrument should the trigger event
occur;
ii. the conversion formula for determining the number of ordinary shares
received upon conversion of the instrument must be determined in advance
in the provisions governing the issuance of the instrument and comply with
legal and regulatory limitations, including limitation on shareholding in
banks;
iii. the issuance of any new shares as a result of the trigger event must
occur prior to any public sector injection of capital (or equivalent support);
iv. Any ordinary shares arising from the conversion may be the ordinary
shares of either the issuing bank, parent company or any other affiliated
entity, including any successor in resolution; and

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v. the provisions governing the issuance of the instrument must specify

that a conversion shall not constitute an event of default for that instrument
or trigger cross-default clauses.

16.3 For Islamic banks, only conversion into ordinary shares is allowed, i.e. no
write offs are permissible.

16.4 It is reiterated that the banks should ensure that the relative offer documents
clearly emphasise the possibility of curtailment of the rights of the holders of the
instrument at the point of non-viability as detailed above, which will override any
other provisions/regulations that may be contained elsewhere. Further it is also
reiterated that prior authorisations for conversion/write-off, CMA‟s clearance etc.
should be in place and restriction of bond holders‟ rights etc. should be
unambiguously mentioned in the offer documents.

17. Disclosure requirements

Banks are required to make available on their websites the full terms and
conditions of all instruments included in regulatory capital. Banks are also required
to make enhanced disclosures on capital as indicated by Basel Committee on
Banking Supervision, beginning from the financial year ending on December 31,
2013, and with every published financial statements thereafter, whether audited or
not.

Separate guidelines on disclosure of capital components have been issued in an

accompanying document (CP-2). As indicated therein, the relevant disclosure
statements (templates) will be forwarded to Banking Surveillance Department on a
quarterly basis.

18. Regulatory process and submission requirements

18.1. A bank is required to obtain the CBO‟s written approval prior for issuance of
regulatory capital in Additional Tier 1 Capital or Tier 2 Capital by the bank, or
issuance to third parties out of a special purpose vehicle. An application must be
accompanied by the following documents/details:
i. a confirmation of compliance by the Chief Executive Officer that the
proposed capital instruments comply with all the criteria for inclusion in capital. In
addition the CBO may require the bank to provide an external legal opinion from a
reputed firm and at the bank‟s expense, confirming that the instrument complies
with all relevant criteria for inclusion in capital.

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ii. indicative (or where available, final) offering documents;

iii. for the purpose of ensuring compliance with the requirements an external
legal opinion:
a. confirming that write-off or conversion into common equity at the
relevant trigger point is enforceable under the bank‟s articles of association,
and relevant company and/or CMA laws;
b. confirming that write-off or conversion into common equity at the
relevant trigger point does not constitute an event of default for that
instrument or trigger cross-default clauses; and
c. highlighting other potential impediments to the write-off or conversion
of the instrument into common/ordinary shares upon a trigger event and
how they have been resolved.

Notwithstanding what is stated above, CBO, at its discretion may call for further
details/documents to clarify matters.

18.2. A bank is required to obtain the CBO‟s written approval prior for making any
planned reduction in its capital, including capital instruments issued out of
consolidated subsidiaries held by third parties. The bank is required to
demonstrate, through its capital plans, that the planned reduction of capital results
in capital levels remaining well above the minimum capital adequacy and capital
buffer requirements, and consistent with its risk profile and business plans.

18.3. Applications in this regard shall be sent to:

Senior Manager
Banking Development Department
Central Bank of Oman

18.4 Banks may note that herein or elsewhere, provisions relating to SPV,
subsidiaries, holding companies etc., though provided for, need to conform to basic
enabling legal and regulatory provisions as and when they accrue.

18.5 Issues possibly arising due to merger, consolidation etc., particularly relating
to Tier 1 and Tier 2 instruments and triggering effects, shall be separately
addressed as and when needed.

Part F
TRANSITIONAL ARRANGEMENTS

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19.1 The capital conservation buffers shall be phased in as follows:-

January 1 Capital Conservation Buffer

Before 2014 0%
2014 0.625%
2015 1.25%
2016 1.875%
2017 2.5%

19.2. The countercyclical capital buffer, applicable if any before 2017 shall be
subject to the following scaling factors, following the pattern of phasing in of the
capital conservation buffer as indicated in paragraph 19.2:

January 1 Counter cyclical Capital Buffer

Before 2014 0%
2014 25%
2015 50%
2016 75%
2017 100%

20 Capital instruments that no longer qualify as non-common equity Tier 1

capital or Tier 2 capital

20.1 The following paragraphs describe the transition arrangements for

instruments recognised as capital under the existing framework prior to 1 January
2013.

Instruments issued in excess of the limits allowed for recognition prior to 1 January
2013 (e.g. Tier 2 Capital exceeding the limit of 100% of Tier 1 Capital) will not be
eligible for the gradual phasing-out treatment. Other such instruments will continue
to be recognized post 2013 subject to a gradual phase out by December 31, 2022,
unless if they meet all the criteria for inclusion set out in paragraphs 13 and 14,
and have received the written approval of the CBO. The phase out treatment has
been described in the following paragraphs.

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20.2 Additional Tier 1 and Tier 2 capital instruments issued prior to August 12,
2012 which do not have any incentives to redeem:
(i) will be fully recognized if they meet all the criteria including point of non
viability criteria;
(ii) will be subject to gradual phase out if they do not meet all the relevant
criteria for inclusion

20.3 Additional Tier 1 and Tier 2 capital instruments issued on, or before, August
12, 2012 (i.e. date of issue of roadmap for implementation of Basel III) that have
call features and incentives to be redeemed, are subject to the following
transitional arrangements:
i. a capital instrument with an effective maturity date on, or before, August
12, 2012 that remains not called after its effective maturity date:
a. will continue to be fully recognised if it meets all the relevant criteria
for inclusion on a forward looking basis; or
b. will be subject to the gradual phase-out treatment if it does not meet
all the relevant criteria for inclusion on a forward looking basis.
ii. a capital instrument with an effective maturity date between, and including,
August 13, 2012 and 31 December 2012 that remains not called after its effective
maturity date:
a. will continue to be fully recognised if it meets all the relevant criteria
for inclusion on a forward looking basis;
b. will be subject to the gradual phase-out treatment if it meets all the
relevant criteria for inclusion on a forward looking basis, with the exception
of the condition relating to point of non viability;
c. will be immediately derecognised if it does not meet all other relevant
criteria for inclusion, on a forward looking basis.

iii. a capital instrument with an effective maturity date on, or after, 1 January 2013
that remains not called after its effective maturity date will be subject to the gradual
phase-out treatment from January 2013, and after its call date:
a. will be fully recognised only if it meets all the relevant criteria for
inclusion on a forward looking basis; and
b. will be fully derecognised if it does not meet all the relevant criteria
for inclusion on a forward looking basis.

x. If the call option is exercised, it will be subject to gradual phase out from
January 1, 2013 till it gets extinguished on exercise of the call.

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20.4 Additional Tier 1 and Tier 2 capital instruments issued between, and
including, August 13, 2012 and December 31,2012 shall be subject to the following
transitional arrangements:
i. a capital instrument meeting all the relevant criteria for inclusion will
continue to be fully recognised;
ii. a capital instrument meeting all the relevant criteria for inclusion (with
the exception of the condition relating to point of non-viability), will be
subject to the gradual phase-out treatment; and
iii. a capital instrument not meeting all other relevant criteria for
inclusion, will be fully derecognised.

21. The gradual phase-out treatment will allow for a limited recognition of certain
capital instruments previously recognised but no longer meeting the criteria for
inclusion as non-common equity Tier 1 or Tier 2 capital, eventually resulting in
such instruments being fully derecognised by December 31, 2022. The treatment
for the limited recognition is as follows:
i. Determine the base for the phase-out treatment, which shall be the
total amounts of Additional Tier 1 and Tier 2 instruments outstanding as on
January 1, 2013 eligible for the gradual phase-out treatment, counted
separately. Share premium on instruments that do not meet the criteria for
entry but are eligible for the transitional arrangements, should be included in
the base. The base amount should also reflect the outstanding amount that
is eligible (including caps and ceilings under BM 1009) for inclusion in the
relevant tier of capital as on December 31, 2012;

ii. The amount of capital instruments eligible for the gradual

phase-out treatment that can be recognised shall be capped at
90% of the base in 2013 (counted separately for Additional
Tier 1 and Tier 2 Capital), with the cap reducing by 10% in
each subsequent year; till it reaches 0% by end of 2022.

iii. To the extent an instrument is redeemed, or its recognition in

capital is amortised after January 1, 2013, the nominal amount
serving as the base is not reduced.

22. It is clarified that CET1 capital instruments, regardless of issuance date, and
Additional Tier 1 and Tier 2 capital instruments issued after 1 January 2013 do not
qualify for any of the transition arrangements described above.

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23. A bank must, prior to November 30, 2013, notify the CBO of the following:

i. for instruments subject to the gradual phase-out treatment, the name of the
issue, nominal amount and first available call date, as well as a calculation of the
base amounts as on 1 January 2013 and
ii. for instruments which meet all the relevant criteria for inclusion on a forward
looking basis (including ordinary shares), a confirmation of compliance by the Chief
Executive Officer. The compliance shall be forwarded to:
Senior Manager
Banking Surveillance Department
Central Bank of Oman

and a copy of the same will be sent to Senior Manager, Banking Development
Department, Central Bank of Oman.

24 Minority interest and capital instruments issued out of subsidiaries and

held by third parties and regulatory filters

Regulatory adjustments of all deductions and prudential filters would be phased in

and deducted from CET1/AT1/T2 so as to be completely implemented by
December 31, 2017.The gradual phase in is given in the following table:-

Year ending Deduction using the

corresponding deduction
approach
2013 20 %
2014 40 %
2015 60 %
2016 80 %
2017 100 %

Any shortfall in mandated deductions shall be deducted from the next higher tier of
capital if the relevant tier of capital is insufficient for the deduction. The remainder
amount not deducted from CET1/AT1/T2 during the transitional arrangement will
be subject to the regulatory adjustments as provided in BM 1009.

*******************************

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CP-1: Guidelines on regulatory capital under Basel III

Annex 1

Illustrative example on minority interest and capital instruments issued out

of consolidated subsidiaries held by third parties

(Reference: Paragraphs 13.1 -13.3 of this document)

A banking group consists of two legal entities that are both banking institutions.
Bank P is the parent and Bank S is the subsidiary and their unconsolidated
balance sheets are set out below:
Bank P balance sheet Bank S balance sheet
Assets Assets

Loans to customers 100 Loans to customers 150

Investment in CET1 of Bank S 7
Investment in the AT1 of Bank S 4
Investment in the T2 of Bank S 2
Total 113 Total: 150

Liabilities and equity Liabilities and equity

Depositors 70 Depositors 127
Tier 2 10 Tier 2 8
Additional Tier 1 7 Additional Tier 1 5
Common equity 26 Common equity 10

Total 113 Total: 150

The balance sheet of Bank P shows that in addition to its loans to customers, it
owns 70% of the ordinary shares of Bank S, 80% of the Additional Tier 1 Capital of
Bank S and 25% of the Tier 2 Capital of Bank S. The ownership of the capital of
Bank S is therefore as follows:

Capital issued by Bank S

Amount issued to Amount Total
Parent (Bank P) issued to
Description
third
parties
Common Equity Tier 1 (CET1) 7 3 10
Additional Tier 1 (AT1) 4 1 5
Tier 1 (T1) 11 4 15
Tier 2 (T2) 2 6 8
Total (TC) 13 10 23

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The consolidated balance sheet of the banking group is set out below:-
Consolidated balance sheet
Assets
Loans to customers 250
Liabilities and equity
Deposits 197
Tier 2 issued by subsidiary to 3rd parties 6
Tier 2 issued by parent 10
Additional Tier 1 issued by subsidiary to 3rd parties 1
Additional Tier 1 issued by parent 7

Common equity issued by subsidiary to 3rd parties 3

Common equity issued by parent 26
Total liabilities & equity 250

For illustrative purposes Bank S is assumed to have risk weighted assets of 100. In
this example, the minimum capital requirements of Bank S and the subsidiary‟s
contribution to the consolidated requirements are the same since Bank S does not
have any loans to Bank P. This means that it is subject to the following minimum
plus capital conservation buffer requirements and has the following surplus capital:

Minimum and surplus capital of bank S

Minimum plus CCB Surplus
Common equity Tier 1 (CET1) 9.50 0.50
Tier 1 (T1) 11.50 3.50
Total Capital (TC) 14.50 8.50

The following table illustrates the calculation of the amount of capital issued by
Bank S to include in the consolidated capital, as indicated in paragraph 13.

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 CP-1: Guidelines on regulatory capital under Basel III

Bank S: amount of capital issued to third parties included in consolidated

capital
Surplus
attributable to Amount
Total Amount 3rd parties, i.e. included
amount issued to Surplus amount excluded in
issued third parties from consolida
consolidated ted
capital capital
(a) (b) (c) (d)=c*b/a (e) =b-d
Common
equity Tier 1
(CET1) 10 3 0.50 0.15 2.85
Tier 1 (T1) 15 4 3.50 0.93 3.07
Total Capital 23 10 8.50 3.70 6.30

A summary of the components of capital for the consolidated group, based on the
amounts calculated above, is given below. The Additional Tier 1 is calculated as
the difference between CET1 and T1, and Tier 2 is the difference between Tier 1
and Total capital.

Summary position of the consolidated group

Description Total amount Amount issued Total amount issued by
issued by parent, by subsidiaries parent and subsidiary
all of which is to to third parties to to be included in
be included in be included in consolidated capital
consolidated consolidated
capital capital
CET1 26 2.85 28.85
AT1 7 0.22 7.22
T1 33 3.07 36.07
T2 10 3.24 13.24
TC 43 6.30 49.30

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CP-1: Guidelines on regulatory capital under Basel III

Annex 2
The 15% of common equity limit on specified items

1. This annex is meant to clarify the calculation of the 15% limit on significant
investments in the common shares of unconsolidated financial institutions
(banks, insurance, takaful, and other financial entities); mortgage servicing
rights, and deferred tax assets arising from temporary differences
(collectively referred to as specified items…please refer to paragraph
no.14.17 of this document.)

2. The recognition of these specified items will be limited to 15% of Common

Equity Tier 1 (CET1) capital, after the application of all deductions. To
determine the maximum amount of the specified items that can be
recognised*, banks and supervisors should multiply the amount of CET1**
(after all deductions, including after the deduction of the specified items in
full) by 17.65%. This number is derived from the proportion of 15% to 85%
(i. e. 15%/85% = 17.65%).

3. As an example, take a bank with RO 85 million of common equity

(calculated net of all deductions, including after the deduction of the
specified items in full).

4. The maximum amount of specified items that can be recognised by this

bank in its calculation of CET1 capital is RO 85 million× 17.65% = RO 15
million. Any excess above RO 15 million must be deducted from CET1. If
the bank has specified items (excluding amounts deducted after applying
the individual 10% limits) that in aggregate sum up to the 15% limit, CET1
after inclusion of the specified items, will amount to RO 85 million + RO 15
million= RO 100 million. The percentage of specified items to total CET1
would equal 15%.

* The actual amount that will be recognised may be lower than this maximum,
either because the sum of the three specified items are below the 15% limit set out
in this annex, or due to the application of the 10% limit applied to each item.
** At this point this is a ʺhypotheticalʺ amount of CET1, in that it is used only for the
purposes of determining the deduction of the specified items.

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