43.Only eligible collateral, guarantees, credit derivatives, and netting under legally enforceable bilateral agreements (such as ISDAs) are eligible for CRM purposes. For example, a commitment to provide collateral or a guarantee is not recognised as an eligible CRM technique for capital adequacy purposes until the commitment to do so is actually fulfilled.

44.No additional CRM will be recognised for capital adequacy purposes on exposures where the risk weight is mapped from a rating specific to a debt security where that rating already reflects CRM. For example, if the rating has already taken into account a guarantee pledged by the parent or sovereign entity, then the guarantee shall not be considered again for credit risk mitigation purposes.

45.Banks should ensure that all minimum legal and the operational requirements set out in the Standard are fulfilled.

CRM treatment by substitution of risk weights

46.The method of substitution of risk weight is applicable for the recognition of the guarantees and credit derivatives as CRM techniques under both the simple approach and the comprehensive approach. Under this method, an exposure is divided into two portions: the portion covered by credit protection and the remaining uncovered portion.

47.For guarantees and credit derivatives, the value of credit protection to be recorded is the nominal value. However, where the credit protection is denominated in a currency different from that of the underlying obligation, the covered portion should be reduced by a standard supervisory haircut defined in the Credit Risk Standard for the currency mismatch.

48.For eligible collateral, the value of credit protection to be recorded is its market value, subject to a minimum revaluation frequency of 6 months for performing assets, and 3 months for past due assets (if this is not achieved then no value can be recognised). Where the collateral includes cash deposits, certificates of deposit, cash funded credit-linked notes, or other comparable instruments, which are held at a third-party bank in a non-custodial arrangement and unconditionally and irrevocably pledged or assigned to the bank, the collateral will be allocated the same risk weight as that of the third party bank.

Simple Approach

49.Under simple approach, the eligible collateral must be pledged for at least the life of the exposure, i.e. maturity mismatch is not allowed.

50.Where a bank has collateral in the form of shares and uses the simple approach, a 100% risk weight is applied for listed shares and 150% risk weight for unlisted shares.

Comprehensive Approach

51.Under the comprehensive approach, the collateral adjusted value is deducted from the risk exposure (before assigning the risk weight). Standard supervisory haircuts as defined in the Credit Risk Standard are applied to the collateral because collateral is subject to risk, which could reduce the realisation value of the collateral when liquidated.

52.If the exposure and collateral are held in different currencies, the bank must adjust downwards the volatility- adjusted collateral amount to take into account possible future fluctuations in exchange rates.

53.There is no distinction for applying supervisory haircuts between main index equities and equities listed at a recognised exchange. A 25% haircut applies to all equities.

Capital Add-on under Pillar 2

54.While the use of CRM techniques reduces or transfers credit risk, it gives rise to other risks that need to be adequately controlled and managed. Banks should take all appropriate steps to ensure the effectiveness of the CRM and to address related risks. Where these risks are not adequately controlled, the Central Bank may impose additional capital charges or take other supervisory actions as outlined in Pillar 2 Standard.