ICAAP Knowledge
ICAAP Knowledge
ICAAP Knowledge
A.
Preface
This guidance is intended to outline the Central Bank of the UAEs (CBUAE) Pillar 2 assessment
framework as initially mandated under the Basel Accord (June 2006) and amended through the
Enhancements to the Basel II Framework (July 2009). In addition, the guidance is designed to be
compliant and consistent with the Basel III guidelines.
The ICAAP document has a dual purpose, both to inform the board and senior management of the
bank as well as the CBUAE of the on-going assessment of the banks risks, how the bank intends
to mitigate those risks and the impact on both internal and regulatory capital where relevant.
The purpose of the guidelines is to enhance the standard of the Internal Capital Adequacy Assessment
Process (ICAAP) for banks in the UAE, whilst recognising that an individual banks ICAAP should be
commensurate and relevant in relation to the risk profile of the institution concerned.
The revised Basel Accord establishes the following four guiding principles for Pillar 2:
1: Internal capital adequacy assessment process (ICAAP): Banks should have a process for
assessing their overall capital adequacy in relation to their risk profile and have a strategy for
maintaining adequate levels of capital.
2: Supervisory review and evaluation process (SREP): Supervisors should review and evaluate a
banks internal capital assessment and strategies for maintaining adequate capital, as well as their
ability to monitor and ensure compliance with the relevant prudential ratios. Appropriate supervisory
measures would be undertaken if the supervisor is not fully satisfied with the outcome of the process.
3: Capital above the minimum requirements: Supervisors should expect banks to operate above the
minimum regulatory capital ratios and should have the ability to require institutions to hold capital in
excess of the minimum.
4: Early intervention system: Supervisors should seek to intervene at an early stage to prevent
capital from falling below the minimum levels required to support the risks the institution is undertaking
and require remedial action to restore an adequate level of capital.
The information contained in the ICAAP should be sufficient for the CBUAE to gain an understanding
and make an informed judgment about the risk profile of the bank and the appropriate level of capital a
bank should hold.
Section B describes the principles and process underpinning the Supervisory Review and
Evaluation Process (SREP) in the UAE
Section C gives further guidance on CBUAEs expectation for the ICAAP process
ICAAP reference manual: The Central Bank will also publish an ICAAP reference manual which
contains further guidance on aspects of the ICAAP process (this will be an informal guide and
does not reflect official policy of the CBUAE)
Material changes: If there is a material change to a banks ICAAP subsequent to its submission,
affecting the capital plan, stress testing programme or any other relevant matter related to the ICAAP,
the bank should formally notify the Central Banks Basel Unit at the Banking Supervision Department
immediately.
These guidelines supersede the requirements set out in section 6 Pillar 2-Supervisory Review and
Annex 3: ICAAP suggested format contained in the CBUAE Capital Adequacy Standards- the
Standardised Approach (November 2009).
The requirements set out in this guideline are effective as of the date of this circular.
These guidelines are applicable to all banks operating in the United Arab Emirates
All Banks must submit an ICAAP annually to the CBUAE no later than 15 April each year.
The ICAAP can be submitted as Word, PowerPoint or PDF file.
Table of Contents
A.
Preface .............................................................................................................................2
B.
Pillar 2 & the ICAAP process in the UAE ..........................................................................5
B.1 Executive Summary ....................................................................................... 5
B.2 Pillar 2 & the ICAAP process in the UAE ..................................................... 10
B.3 CBUAE Supervisory Review and Evaluation Process (SREP) Principles .... 11
B.4 CBUAE ICAAP Principles............................................................................. 11
C.
ICAAP guidelines ............................................................................................................13
C.1 Executive Summary and conclusions .......................................................... 13
C.2 Overview of ICAAP process & the USE test ............................................... 13
C.3 Business background and group structure ................................................... 14
C.4 Governance and risk management arrangements ....................................... 15
C.5 Risk appetite ................................................................................................ 16
C.6 Pillar 1 Risks and Calculation Methodologies .............................................. 16
C.7 Pillar 2 Risk Assessment.............................................................................. 17
C.8 Guidance on Pillar 2 Risk ............................................................................. 18
C.9 Capital planning ........................................................................................... 20
C.10 Stress and scenario testing ........................................................................ 22
C.11 Business Model Analysis (BMA) ................................................................ 25
C.12 Risk and diversification benefits ................................................................. 25
C.13 Ratings Risk ............................................................................................... 25
C.14 Islamic banks ............................................................................................. 26
D. Annexes .................................................................................................................................I
Annex 1: ICAAP: Mandatory disclosure form ................................................... I
Annex 2: ICAAP projection tables (n.b. this table is for illustrative purposes only) II
Annex 3: Capital planning summary .................................................................... III
Annex 4: References The following are for reference purposes only .................. IV
Annex 5: Glossary ................................................................................................ V
B.
There may be cases where branches of a foreign bank and smaller, less complicated local banks have
a different approach to some elements of the requirements outlined in this guideline. This may be
acceptable under the concept of proportionality so long as they are able to demonstrate the relevance
of their approach in the key aspects of the ICAAP such as risk management, identification of material
risks, capital planning and stress testing. The bank should indicate this clearly in the ICAAP document
and the reasons for any alternative approach.
Foreign banks may adhere to group policies/guidelines and may not conduct stress testing on a standalone basis. The CBUAE has no objection to these alternative approaches so long as the reasons for
doing so are clearly articulated.
Pillar 2 Process
Pillar 2 is one of the three fundamental Pillars underpinning the Basel Accord. As per Circular 27/2009
regarding the implementation of Basel II in the UAE, all banks must have a process for assessing the
overall capital adequacy in relation to their risk profile and a strategy for maintaining adequate capital. A
thorough and comprehensive internal capital adequacy assessment process (ICAAP) is a vital
component of a robust risk management programme. This guidance is intended to assist banks in
better identifying and managing risks in the future and in appropriately capturing risks in their internal
assessments of capital adequacy.
As part of the Pillar 2 process the CBUAE will undertake a Supervisory Review and Evaluation Process
(SREP) in order to review a banks ICAAP assessment and provide feedback as relevant.
The suggested summary contents for an ICAAP are set out in the ICAAP reference manual
The key components of the ICAAP are as follows:
1. Senior management and board oversight
2. Relevance of the ICAAP in identifying all material risks and the aggregate capital requirement
3. Level of disclosure to the Central Bank
4. Specific Pillar 2 risks
5. Capital Planning and Capital Management Plan (CMP)
6. Stress testing
1: Senior management and board oversight
Oversight: The ICAAP report is an internal document; the ICAAP should be approved by the board of
directors or relevant risk/governance committee. There should be sufficient challenge by the board or
senior management on material issues (and the bank should evidence this). The bank should specify
the individual responsible for the ICAAP process (this may or may not be the CRO).
The board or relevant risk/governance committee bears final responsibility for the assessment and for
any corresponding disclosures. Any deviation from these guidelines should be disclosed and discussed
with the CBUAE. The Bank should specify who signed-off the ICAAP (in addition to the CRO who must
sign the mandatory disclosure form). The ICAAP should be submitted on an annual basis. The ICAAP
submission should include the mandatory disclosure form set out in the Annex.
Senior management and board understanding: It is imperative that the bank establishes a
programme to ensure all senior management and board members understand the purpose and nature
of the ICAAP report (especially in terms of capital planning). All senior management and board
members are expected to demonstrate an understanding of the ICAAP process and familiarity with the
content of the executive summary of the ICAAP guidelines by means of relevant training and or
workshops. The Central Bank will review and verify senior management and board understanding of
the ICAAP during the SREP review.
2: Relevance of the ICAAP in identifying all material risks and the aggregate capital requirement.
The Basel Accord acknowledges that Pillar 1 regulatory capital may not necessarily be sufficient to
cover all the risks a bank is facing. ICAAP is the process that enables a prudent bank to identify the
material risks it is facing and assess the capital impact.
The CBUAE considers that a key element of the ICAAP process is for a bank to identify, disclose and
assess the capital impact of all material risks. Banks should carefully consider all risks affecting their
business and derive their individual risk profile accordingly.
In order to assess whether or not a risk is to be deemed material, bank management has to obtain an
overview of the institutions risks at regular intervals and on an event-driven basis. The risks are to be
identified at the level of the individual bank as a whole regardless of which organisational unit the risks
were caused.
For each material risk identified, the bank should provide an explanation of how the risk has been
assessed, the quantitative results (if relevant), and the additional capital set aside for these risks.
3: Level of disclosure to the Central Bank
The CBUAE will be basing the ICAAP review (or SREP) predominantly on the information contained in
the ICAAP. The information contained in the ICAAP should therefore be sufficient for the CBUAE to
gain an understanding and make an informed judgment about the risk profile of the bank and the
appropriate level of capital a bank should hold.
4: Specific Pillar 2 risks
Concentration risk
The CBUAE considers concentration risk a material Pillar 2 Risk in the UAE. Basel II is calibrated to
large diversified, internationally credit institutions. It is clear that a majority of banks in the UAE are
inherently more concentrated than large diversified international banks. In the context of Pillar 2 a bank
is required to assess and monitor sector, obligor and product concentrations. A bank may use its credit
portfolio models if relevant.
For local banks with foreign operations the CBUAE expects the capital planning to include the risks in
the foreign operations.
6: Stress testing
This is a vital tool and is a critical element of risk management. Stress testing is acknowledged by
regulators as a key regulatory tool and board and senior management involvement in the stress testing
programme is essential. All banks should consider the impact on their business when adverse
circumstances arise.
The bank must:
The bank should provide a high level summary of the banks approach to stress testing. Banks are be
required to define a number of relevant idiosyncratic, market wide and combination (idiosyncratic and
market wide) stresses and disclose the results of these.
Capital buffer for stress testing:
A bank should decide whether a capital buffer is required for stress testing, the bank should have a
clear process in this regard which has been formally approved by relevant management/board
committee.
If a capital buffer is maintained the bank should indicate for what particular level of stress capital is kept
(where no capital buffer is maintained the bank will need to clearly indicate how it will meet its
regulatory capital requirements in the medium term with due regard to stressed economic conditions).
Mandatory CB UAE ICAAP disclosure form
All banks are required to submit the mandatory ICAAP disclosure form which must be signed by the
CRO (the actual ICAAP should be signed off by the relevant risk/board committee as outlined above).
The disclosure form is set out in the annex.
Submission of
ICAAP
Supervisory Review
and Evaluation
Process (SREP)
CBUAE review
Recommended
Action Plan (RAP)
Discuss findings &
issue RAP
Issue Supervisory
Capital Guidance
CBUAE to set a bank
specific capital ratio
10
Risk-based assessment: When considering the ICAAP the focus will be on material risks and
issues, and making comparisons with peer group banks where relevant.
Systemic risk: The Central Bank will also consider the size and importance of the bank within
the UAEs financial system
Scope of review: The scope and depth of a review will depend on the size of the bank and
quality of the ICAAP document
Diversification: The Central Bank will only consider diversification benefits on a case-by-case
basis if the bank can demonstrate the relevance to their individual portfolio.
11
12
C.
ICAAP guidelines
The bank should complete and sign the mandatory disclosure form set out in the annex.
The purpose of the report and summary of the ICAAP approach/ methodology
The key findings of the ICAAP in particular with respect to the Pillar 2 risk assessment, the
capital plan and stress testing
Other relevant matters
Senior management challenge of the ICAAP process
13
14
Organisation of the Risk function including powers, responsibilities and areas where
responsibility has been delegated.
How the bank identifies, measures, monitors and reports material risks
Details of relevant policies, procedures and limits (these do not need to be set out in detail in the
ICAAP, the document should simply cross refer to the relevant policies, procedures and limits
where relevant)
Risk Management Information Systems (MIS), issues to consider:
o How the bank disseminates regular, accurate and timely information on the banks
aggregate risk profile internally
o The nature, frequency and distribution on risk management information
15
Year 1
Year 2
Year 3
16
Pillar 2 risks
Capital required (AED 000s)
e.g. Credit Concentration risk
Interest rate risk in the banking book
Liquidity risk
Business risk
..
Total Pillar 2 add-on
17
Characteristics: Risk characteristics and how the risk might affect the bank;
Methodology: In assessing/quantifying risk
Crystallisation: Likelihood of crystallisation of risk (net of controls) where possible
Capital impact: Whether the capital held under Pillar 1 in respect of that risk is sufficient and if
additional capital will be held with respect to the individual risk concerned
18
19
Table
Forecast period
Details
Reference
Capital adequacy
summary
ICAAP reference
manual
ICAAP reference
manual
P&L
Balance sheet
ICAAP reference
manual
The projected capital adequacy summary table is set out in the annex. All Banks should include this
table or equivalent in the ICAAP document.
The tables setting examples of the above for all the aforementioned projections are set out in the
ICAAP reference manual.
Historic Disclosure
Provide a summary of historic capital base, aggregate RWAs and CAR ratio for a minimum of five years
or more if data is available (as per the table highlighted in the annex)
Capital Planning: Objective
Capital planning and stress testing are interrelated topics and a bank should approach these
two elements of the ICAAP in a holistic manner. The base case capital plan can be used as the
base case for stress testing.
The objective of capital planning is to ensure the bank can meet its minimum capital requirements at all
times, hence it may be prudent for a bank to keep capital for a reasonably severe economic recession.
The bank must detail how it would manage its business and capital whilst maintaining the minimum
capital requirements.
An economic downturn would impact both
The banks capital resources and future earnings
The banks RWA (taking into account future changes to the balance sheet).
20
Capital planning and stress testing are related, a bank need not explicitly consider an economic
downturn or other types of scenario in its formal capital plan if this is considered in the scenario and
stress testing analysis.
The CBUAE disclosure requirements
The bank should summarise the capital management plan and relevant management actions (see
guidance below). The level of information should be sufficient for the Central Bank to gain an
understanding of:
(A) The capital management plan. The plan should include the following (to maintain minimum capital
requirements)
(B) Contingency buffer
(C) Relevant management actions
(D) Access to additional capital
Process used to identify capital requirements in a stressed scenario
A fundamental feature of any Pillar 2 assessment is that it is forward-looking in nature. We would
expect banks to assess the adequacy of capital (by projecting their capital requirements and available
capital) for at least 2-3 years.
In order to facilitate understanding of the capital requirements over the medium term the bank should
take the following steps:
1) Take the base case scenario: projections of key financial data (from the business plan)
2) Apply relevant stresses and analyse the effect on the base case (projections prior to any
management actions)
3) Identification of the capital requirement
Central Bank of the UAE ICAAP guideline
21
22
Stress testing
Banks own stress tests: Banks will be required to define a number of relevant idiosyncratic, market
wide and combination (idiosyncratic and market wide) stresses and disclose the results of these.
The bank should:
Undertake stress testing on a forward-looking basis.
Have clearly documented policies and procedures to enable effective implementation of a stress
testing programme
Ensure senior management take ownership and responsibility for the implementation of an
effective stress testing programme
Stress testing principles The CBUAE considers that banks should have a comprehensive stress
testing programme/ framework and should be mindful of the principles below:
Stress testing should form an integral part of the overall governance and risk management
culture of the bank
Senior management should take an active interest in the development in and operation of stress
testing
Stress testing should be forward-looking
Stress tests should measure the impact on regulatory capital
The nature of the stress testing programme/framework should be commensurate to the nature,
size and complexity of the bank
Banks may find it useful to consider the principles outlines in the BIS Principles for sound stress
testing practices and supervision (May 2009).
23
24
25
Islamic banking windows: conventional banks which also offer Islamic financial services or products
26
D. Annexes
Annex 1: ICAAP: Mandatory disclosure form
All banks are required to disclose the following information as a separate cover sheet when submitting the ICAAP document to the Central Bank:
Bank
Date
Relevant contact point and contact details
Scope of ICAAP (entities included)
XXXX
20XX
[date]
Annex 2: ICAAP projection tables (n.b. this table is for illustrative purposes only)
II
2
RATIO
ORDINARY PLANNING
Financial Year +1
3
5
RATIO
Financial Year + 2
6
8
RATIO
Financial Year + 3
9
Estimated Regulatory
capital requirement
10
Estimated Regulatory
Capital
2
RATIO
Financial Year +1
3
5
RATIO
Financial Year+2
6
1
2
3
4
5
FY
1
Amount
FY+1
2
Amount
FY+2
3
Amount
FY+3
4
Amount
III
8
RATIO
Financial Year+3
9
Estimated Regulatory
capital requirement
10
Estimated Regulatory
Capital
BIS Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework Comprehensive
Version, June 2006.
BIS, Basel III: A global regulatory framework for more resilient banks and banking systems, December 2010
BIS Basel III: International framework for liquidity risk measurement, standards and monitoring, December 2010
Stress testing
BIS, Principles for sound stress testing and supervision, May 2009
Liquidity
BIS, Basel III: International framework for liquidity risk measurement, standards and monitoring, December 2010
Other
BIS, Range of practices and issues in economic capital frameworks, March 2009
IV
Annex 5: Glossary
The following abbreviations are used in this guideline
AD
Abu Dhabi
BIS
BB
Banking Book
CBUAE
CEBS
Committee for European Banking Supervisors (now EBA European Banking Authority)
CDS
DXB
Dubai
GCC
ICAAP
LGD
PD
Probability of Default
RST
RWA
SREP
SRP
TB
Trading Book
UAE
SCG
IRRBB
BMA
VI