47.The Central Bank will assess the degree to which internal requirements and processes incorporate the full range of material risks faced by the bank. The Central Bank will also review the adequacy of risk measures used in assessing internal capital adequacy and the extent to which these risk measures are also used operationally in setting limits, evaluating business line performance, and evaluating and controlling risks more generally. In addition, the Central Bank will review the results of stress tests (including sensitivity analyses and scenario analyses) conducted by the banks and how these results relate to capital plans.

48.The Central Bank will review the bank’s processes to determine that:

1. i.Minimum capital requirements chosen are comprehensive and relevant to the current operating environment and the risk profile of the bank;
2. ii.Minimum capital requirements are properly monitored and reviewed by senior management; and
3. iii.The composition of capital is appropriate for the nature and scale of the bank’s business.

49.The Central Bank will also consider the extent to which the bank has provided for unexpected events in setting its minimum capital requirements. This analysis must cover a wide range of external conditions and scenarios, and the sophistication of techniques and stress tests used must be commensurate with the bank’s activities.

50.The Central Bank will consider the quality of the bank’s management information reporting and systems, the manner in which business risks and activities are aggregated, and management’s record in responding to emerging or changing risks.

51.In all instances, the capital requirement at an individual bank must be determined according to the bank’s risk profile and adequacy of its risk management process and internal controls. External factors such as business cycle effects and the macroeconomic environment must also be considered. Another consideration is the variability in a bank’s profitability in normal circumstances.

52.In order for certain internal methodologies (e.g. VaR), credit risk mitigation techniques and asset securitisations to be recognised for regulatory capital purposes, banks will need to meet a number of requirements, including risk management standards and disclosures. In particular, banks will be required to disclose features of their internal methodologies used in calculating minimum capital requirements. As part of the supervisory review process, the Central Bank will ensure that these conditions are met on an ongoing basis.

53.The Central Bank regards this review of as an integral part of the supervisory review process under Principle 2.

54.The Central Bank will also perform a review of compliance with certain conditions and requirements set for standardised approaches.

Principle 3: The Central Bank expects banks to operate above the minimum regulatory capital ratios and may require banks to hold capital in excess of the minimum.

55.The Central Bank will take appropriate action if it is not satisfied with the results of the bank’s own risk assessment and capital allocation or with the minimum capital levels as determined by the bank. The Central Bank will add additional capital requirements where the Central Bank is not satisfied that all risks have been identified. Important to note is that banks shall not disclose this publicly.

56.Pillar 1 capital requirements shall include a buffer for uncertainties surrounding the Pillar 1 regime that affect the banking population as a whole. Bank-specific uncertainties will be treated under Pillar 2. The Central Bank require banks to operate with a buffer, over and above the Pillar 1 standards. Banks must maintain this buffer for example:

1. i.Pillar 1 minimums are anticipated to be set to achieve a level of bank creditworthiness in markets that is below the level of creditworthiness sought by many banks for their own reasons. For example, most international banks appear to prefer to have low risk profile and thus be highly rated by internationally recognised rating agencies. This is currently the case in the UAE. Thus, banks are likely to choose to operate above Pillar 1 minimums for competitive reasons.
2. ii.In the normal course of business, the type and volume of activities will change, as will the different risk exposures, causing fluctuations in the overall capital ratio.
3. iii.It may be costly for banks to raise additional capital, especially if this needs to be done quickly or at a time when market conditions are unfavourable.
4. iv.For banks to fall below minimum regulatory capital requirements is a serious matter. It will place banks in breach of the relevant law and/or prompt nondiscretionary corrective action on the part of supervisors such as withdrawal of license.
5. v.There may be risks, either specific to individual banks, or more generally to an economy at large, that are not taken into account in Pillar 1. The Central Bank uses its own internal benchmarks and may request banks at any time for additional data to calculate an add-on.

57.There are several means available to the Central Bank for ensuring that individual banks are operating with adequate levels of capital. Among other methods, the Central Bank may set higher minimum capital requirements or define categories above minimum ratios (e.g. well capitalised and adequately capitalised) for identifying the capitalisation level of the bank.

Principle 4: The Central Bank will intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank and will require rapid remedial action if capital is not maintained or restored.

58.The Central Bank will consider a range of options if it becomes concerned that a bank is not meeting the requirements embodied in the supervisory principles outlined above. These actions may trigger the recovery plan that includes and not limited to intensifying the monitoring of the bank, restricting the payment of dividends, requiring the bank to prepare and implement a satisfactory capital adequacy restoration plan, and requiring the bank to raise additional capital immediately. The Central Bank have the discretion to use the tools best suited to the circumstances of the bank and its operating environment.

59.The permanent solution to banks’ difficulties is not exclusively increased capital. However, some of the required measures (such as improving systems and controls) may take some time to implement. Therefore, increased capital requirements might be used as an interim measure while permanent measures to improve the bank’s position are being put in place. Once these permanent measures have been put in place and have been seen by the Central Bank to be effective, the interim increase in capital requirements may be removed.