United Arab Emirates: UAE Central Bank Issues New Rules Aligning With Basel III

Last Updated: 2 August 2017
Article by Global Business Services DMCC

Capital adequacy regulations were introduced by the Central bank of the UAE on 1st February to ensure if the capital adequacy of all banks operating in the UAE is aligned with the revised rules outlined by the Basel Committee on Banking Supervision in Basel III, a global regulatory framework. These regulations are further supported by accompanying standards, which elaborate on the supervisory expectations of the Central Bank with respect to capital adequacy requirements. They are issued in accordance with the powers bestowed in the central bank under the Central Bank Law.

According to the Central Bank, to encourage the effective and efficient development and functioning of the banking system, banks are required to manage their capital in judicious way. A strong capital must support the risk taken by the banks to maintain stability of the financial system of the UAE.

Banks must ensure that the regulations and the accompanying 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.

The total regulatory capital comprises the sum of two tiers where Tier 1 capital is composed of a common equity Tier 1 (CET 1) and an additional Tier 1 (AT1). UAE banks must ensure that CET1 must not be less than 7% of risk-weighted assets (RWA) while tier 1 capital must not be less than 8.5 % of RWA. The total capital of the sum of the two tiers must be minimum 10.5 % of RWA. A bank must comply with the individual SCG requirement set by the Central Bank. Some banks might have to increase their capital if required by regulations and review and evaluation by the Central Bank.

CET1 capital comprises of common shares issued by a bank, share premium resulting from the issue of instruments, retained earnings; legal reserves, statuary reserves, accumulation of 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 and regulatory adjustments applied in the calculation of CET1. These items are eligible for inclusion in CET 1. AT1 capital consists of instruments issued by a bank, stock surplus or share premium resulted from the issue of instruments included in AT1, instruments issued by consolidated subsidiaries of the bank and held by third parties These items are eligible for incorporation in AT1 and not in CET1.

For banks using the standardized approach for credit risk, tier 2 capital comprises of general provisions/general loan loss reserves up to a maximum of 1.25% of credit RWA, constant equity instruments, solving 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 and 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 the central bank said. Central bank added that investment risk reserves and a portion of the profit equalization reserve (PER), if any, belong to the equity of investment account holders and must not be classified as part of an Islamic bank's regulatory capital since the purpose of a PER is to smooth the profit payouts and not to cover losses.

Regulatory adjustments must be applied to CET1 capital for delayed tax assets; cash flow hedge reserve; gain on sale related to securitization transactions; collective profit 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 and significant investments in capital of banking, financial and insurance entities which is not in scope of regulatory consolidation and threshold deductions.

Certain securitization exposures include nonpayment/ delivery on non-delivery-versus-payment and non-payment-versus-payment transactions and significant investments in commercial entities. Banks are encouraged to keep buffer of 2.5 per cent of RWAs in the form of CET1 capital in addition to the minimum CET1 capital of seven per cent of RWA. A bank that does not meet the buffer requirement must follow a definite plan to restore the buffer as a part of its internal capital assessment process within a time limit agreed with the Central Bank.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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