The Central Bank of the UAE has issued new regulations to ensure that capital adequacy of all banks operating in the UAE is in line with revised rules outlined by the Basel Committee on Banking Supervision in Basel III, a global regulatory framework for more resilient banks and banking systems.
The capital adequacy regulations, which became effective on 1st February, are supported by accompanying standards, which elaborate on the supervisory expectations of the Central Bank with respect to capital adequacy requirements, said Chairman of the Board of the Central Bank of the UAE, Khalifa Mohammed Al Kindi.
"In introducing these Capital Adequacy Regulations, the Central Bank intends to ensure that banks’ capital adequacy is in line with revised rules outlined by the Basel Committee on Banking Supervision in ‘Basel III. To this end, banks are required to manage their capital in a prudent manner. It is important that banks’ risk exposures are backed by a strong capital base of high quality in order to contribute to the stability of the financial system of the UAE," the apex bank said in a circular sent to banks.
These regulations and the accompanying standards are issued pursuant to the powers vested in the Central Bank under the Central Bank Law, Al Kindi added.
The Central Bank said that it seeks to promote the effective and efficient development and functioning of the banking system. "To this end, banks are required to manage their capital in a prudent manner. It is important that banks’ risk exposures are backed by a strong capital base of high quality in order to contribute to the stability of the financial system of the UAE."
"These regulations and the accompanying standards apply to all banks. Banks must ensure that these regulations and standards are adhered to on the following two levels:
The solo level capital adequacy ratio requirements, which measure the capital adequacy of an individual bank based on its standalone capital strength; and the group level capital adequacy ratio requirements, which measure the capital adequacy of a bank based on its capital strength and risk profile after regulatory consolidation of assets and liabilities of its subsidiaries."
Article 2 of the regulations explains quantitative requirements and states that the total regulatory capital comprises the sum of two tiers, where Tier 1 capital is composed of a common equity Tier 1 (CET1) and an additional Tier 1 (AT1).
Banks must comply with the following minimum requirements, at all times:
- CET1 must be at least 7.0 per cent of risk weighted assets (RWA)
- Tier 1 Capital must be at least 8.5 per cent of RWA
- Total Capital, calculated as the sum of Tier 1 Capital and Tier 2 Capital, must be at least 10.5 per cent of RWA.
According to the regulations, and based on the outcome of the Supervisory Review and Evaluation Process conducted by the Central Bank, a bank may be subject to an additional capital add-on, also referred to as individual supervisory capital guidance requirement (SCG).
The concerned banks must comply with the individual SCG requirement set by the Central Bank.
Article 3 which explains capital components states that CET1 capital comprises the sum of the following items: Common shares issued by a bank which are eligible for inclusion in CET1;
Share premium resulting from the issue of instruments included in CET1; retained earnings; legal reserves; statutory reserves; accumulated other comprehensive income and other disclosed reserves; common shares issued by consolidated subsidiaries of a bank and held by third parties, also referred to as minority interest, which are eligible for inclusion in CET1; regulatory adjustments applied in the calculation of CET1.
AT1 capital comprises the sum of the following items: instruments issued by a bank which are eligible for inclusion in AT1 and are not included in CET1; stock surplus, or share premium, resulting from the issue of instruments included in AT1; instruments issued by consolidated subsidiaries of the bank and held by third parties which are eligible for inclusion in AT1 and are not included in CET1; regulatory adjustments applied in the calculation of AT1.
Tier 2 capital, for banks using the standardised approach for credit risk, comprises the sum of the following items: General provisions/general loan loss reserves up to a maximum of 1.25 per cent of credit RWA; perpetual equity instruments, not included in Tier 1 capital; share premium resulting from the issue of instruments included in Tier 2 capital; instruments which are eligible for inclusion of Tier 2; perpetual instruments issued by consolidated subsidiaries, not included in Tier 1 capital; regulatory adjustments applied in the calculation of Tier 2.
Profit-sharing investment accounts must not be classified as part of an Islamic bank’s regulatory capital as referred to in Article 2 of these regulations, the Central Bank said.
Investment risk reserves and a portion of the profit equalisation reserve (PER), if any, belong to the equity of investment account holders, and thus must not be used in the calculation of an Islamic bank’s regulatory capital. As the purpose of a PER is to smooth the profit payouts and not to cover losses, any portion of a PER that is part of the Islamic bank’s reserves must not be treated as regulatory capital as referred to in Article 2 of these Regulations.
Regulatory adjustments stated in Article 4 must be applied to CET1 capital as follows:
Goodwill and other intangibles; deferred tax assets; cash flow hedge reserve; gain on sale related to securitisation transactions; cumulative gains and losses due to changes in own credit risk on fair valued financial liabilities; defined benefit pension fund assets and liabilities; investments in own shares, or treasury stock; reciprocal cross holdings in the capital of banking, financial and insurance entities; investments in the capital of banking, financial and insurance entities, that are outside the scope of regulatory consolidation and where the bank does not own more than 10 per cent of the issued common share capital of the entity; significant investments in capital of banking, financial and insurance entities that are outside the scope of regulatory consolidation; threshold deductions.
For the following items, which under Basel II were deducted 50 per cent from Tier 1 and 50 per cent from Tier 2, or had the option of being deducted or risk weighted, banks must apply a risk weight, which is calculated as the reciprocal of the minimum requirement of the Total Capital.
Certain securitisation exposures include the following: Non-payment/delivery on non-Delivery-versus-Payment and non-Payment-versus-Payment transactions; significant investments in commercial entities.
In addition to the minimum CET1 capital of 7.0 per cent of RWA, banks must maintain a capital conservation buffer (CCB) of 2.5 per cent of RWAs in the form of CET1 capital, according to Article 5 of the regulations.
Outside of periods of stress, banks are encouraged to hold buffers of capital above the capital adequacy requirements.
A bank that does not comply with the buffer requirement must restrict its dividends pay out to its shareholders; must have a definite plan to replenish the buffer as part of its internal capital adequacy assessment process; must bring the buffer to the required level within a time limit agreed with the Central Bank; and will be monitored closely by the Central Bank.