• BANK Chapter 5 BANK Chapter 5 Concentration risk and related matters

    Amended by QFCRA RM/2015-3 (as from 1st January 2016).

    • BANK Part 5.1 BANK Part 5.1 General

      • BANK 5.1.1 Introduction

        This Chapter sets out the requirements for a banking business firm's policies to identify, measure, evaluate, manage and control or mitigate concentrations of risk. This Chapter also sets limits on the firm's exposures to individual counterparties and connected counterparties.

        Note Safeguarding against risk concentrations is an essential part of a banking business firm's credit risk management policy — see rules 4.2.2 and 4.3.2.

        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.1.2 Concept of connected parties

        (1) The concept of parties being connected to one another is used in these rules in relation to counterparties or issuers with which a banking business firm has exposures. Connected counterparties are the basis for the measurement of concentration risk and large exposures.
        (2) In contrast, the concept of parties being related to the banking business firm (which is discussed with credit risk in Chapter 4) is primarily used in relation to the requirement that the firm's transactions be at arm's length.
        (3) It is of course possible for a firm's related parties to be connected counterparties (such as when the firm has exposures to them).

        Note For purposes of concentration risk, the firm's exposure to connected counterparties (whether related or not) is taken to be a single risk.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.1.3 Connected parties

        (1) A party is connected to another party if they are linked by:
        (a) cross guarantees;
        (b) common ownership;
        (c) common management;
        (d) one having the ability to exercise control over the other, whether direct or indirect;
        (e) financial interdependency — that is, the financial soundness of one may affect the financial soundness of the other; or
        (f) any combination of the factors mentioned in paragraphs (a) to (e).
        Guidance

        1 Parties would be connected if the same persons significantly influence the governing body of each of them.
        2 Parties would be connected if one of them has an exposure to the other that was not incurred for the clear commercial advantage of both of them and is not on arm's length terms.
        3 Parties would be connected if they are so closely linked that:
        (a) the insolvency or default of 1 is likely to be associated with the insolvency or default of the other;
        (b) it would be prudent when assessing the financial condition or creditworthiness of 1 to consider that of the other; or
        (c) there is, or is likely to be, a close relationship between their financial performance.
        4 Parties would be connected if a banking business firm has exposures to them and any loss to the firm on any of the exposures to 1 of the parties is likely to be associated with a loss to the firm with respect to at least 1 exposure to each of the others.
        (2) A counterparty may be connected to another counterparty by other linkages that, in the banking business firm's assessment, connect the counterparties as constituting a single risk. A connected party can be an individual or other entity.

        Guidance

        1 Two or more individuals or legal persons would constitute a single risk if they are so connected that, if 1 of them were to experience financial problems, the other or others would be likely to encounter repayment difficulties.
        2 Connected counterparties should be identified and the procedures to manage the combined credit risk considered. A banking business firm may need to monitor and report the gross exposure to connected counterparties against combined limits in addition to monitoring the exposure to each counterparty.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.1.4 Role of governing body — concentration risk

        (1) A banking business firm’s governing body must ensure that the firm’s concentration risk management policy gives a comprehensive firm-wide view of the significant sources of concentration risk (including on-balance-sheet exposures, off-balance-sheet exposures and exposures from contingent liabilities).
        (2) The governing body must also ensure that the firm’s senior management monitors the limits set in this Chapter and that those limits are not exceeded on a solo or consolidated basis.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK Part 5.2 BANK Part 5.2 Concentration risk

      • BANK 5.2.1 BANK 5.2.1 Concentration risk

        Concentration risk to a banking business firm arises if the firm is exposed to 1 counterparty, or to 2 or more counterparties that are not truly independent of each other, and the total of the exposures to the counterparty or counterparties is large enough to endanger the firm’s liquidity or solvency.

        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

        • BANK 5.2.1 Guidance

          1 Significant sources of concentration risk include:
          (a) concentration of exposures to a single counterparty or connected counterparties;
          (b) concentration of exposures to counterparties in the same industry, sector, region or country; and
          (c) concentration of exposures to counterparties whose financial performance depends on the same activity or commodity.
          2 A concentration of exposures would also arise if a firm accepts collateral or credit protection provided by a single provider.
          Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.2.2 BANK 5.2.2 Policies — concentration risk sources and limits

        (1) A banking business firm’s concentration risk policy must set limits for acceptable concentrations of risk, consistent with the firm’s risk tolerance, risk profile and capital. The limits must be made known to, and must be understood by, all relevant staff.
        (2) The policy must ensure that:
        (a) the firm’s information systems identify exposures creating risk concentrations and large exposures to single counterparties or connected counterparties, aggregate those exposures and facilitate their management; and
        (b) all significant such concentrations and exposures are reviewed regularly and reported to the firm’s governing body or senior management.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

        • BANK 5.2.2 Guidance

          A banking business firm's policies should be flexible to help the firm to identify risk concentrations. To achieve this, the systems should be capable of analysing the firm's credit portfolio by:

          •   size of exposure
          •   exposure to connected counterparties
          •   product
          •   geography
          •   industry or sector (for example, manufacturing and industrial)
          •   account performance
          •   internal credit risk assessment
          •   funding
          •   outstandings versus commitments
          •   types and coverage of collateral.
          Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.2.3 Relation to stress-testing

        When carrying out stress-testing or review of stress scenarios, a banking business firm must take into account significant risk concentrations and large exposures, and the effects of changes in market conditions and risk factors on them.

        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK Part 5.3 BANK Part 5.3 Management of exposures

      Amended by QFCRA RM/2015-3 (as from 1st January 2016).

      • BANK 5.3.1 Calculating exposures

        (1) Large exposure means a gross exposure to a counterparty or connected counterparties that is 10% or more of the firm's regulatory capital.

        Note Regulatory capital is defined in rule 3.2.7.
        (2) In this rule:

        gross exposure to a counterparty or connected counterparties is the total of the following exposures:
        (a) on-balance-sheet and off-balance-sheet exposures;
        (b) debt securities held by the firm;
        (c) equity exposures.
        (3) In calculating the gross exposure, include:
        (a) the outstanding balances of all loans and advances, including balances with other banks;
        (b) holdings of debt or equity securities;
        (c) unused off-balance-sheet commitments, whether revocable or irrevocable; and
        (d) the credit equivalent amounts of all market-related transactions (calculated in accordance with rule 4.4.11, or Division 4.5.E if netting applies).
        (4) However, in calculating the gross exposure, do not include:
        (a) claims, equity investments and other exposures deducted from the firm's capital;
        (b) exposures arising in the course of settlement of market-related contracts; and
        (c) exposures that have been written off.
        (5) For this Part:
        (a) a banking business firm must treat an exposure as reduced (to the extent permitted by Part 4.5) by any applicable CRM technique; and
        (b) a banking business firm that is part of a financial group may offset intragroup amounts due to other deposit takers within the group.
        Amended by QFCRA RM/2017-2 (as from 1st April 2017).

      • BANK 5.3.2 Policies — large exposures

        A banking business firm’s large exposure policy must include:

        (a) exposure limits, commensurate with the firm’s risk tolerance, risk profile and capital, for:
        (i) categories of counterparties (for example, sovereigns, other authorised firms and other financial entities, corporate and individual borrowers);
        (ii) connected counterparties;
        (iii) particular industries or sectors;
        (iv) particular countries; and
        (v) asset classes (for example, property holdings);
        (b) the circumstances in which the exposure limits may be exceeded;
        (c) the procedures for approving exceptions to, and deviations from, exposure limits or policies; and
        (d) the procedures for identifying, measuring, managing and reporting large exposures.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.3.3 Limits on exposures

        (1) A banking business firm must not become exposed without limit to a single counterparty. The firm must not give a general guarantee of the obligations of a counterparty.
        (2) The total of the firm's net exposures to any 1 counterparty or any 1 group of connected counterparties must not exceed 25% of the firm's regulatory capital.
        (2A) The total of all of the firm's net large exposures must not exceed 800% of that capital.

        Note Subrules (2) and (2A) do not apply to a branch. A branch is not required to hold regulatory capital — see rule 3.1.2(1).
        (3) A banking business firm may apply to the Regulatory Authority for approval for a proposed exposure in excess of the limits set out in this Chapter. An approval will be granted only in exceptional circumstances and only after the firm satisfies the authority that the proposed exposure does not expose the firm to excessive risk.
        (4) The Regulatory Authority may impose a higher capital ratio on the firm to compensate for the additional risk associated with the proposed exposure.
        Amended by QFCRA RM/2015-3 (as from 1st January 2016).

      • BANK 5.3.4 BANK 5.3.4 Limits on exposures — Islamic financial managers [Deleted]

        Deleted by QFCRA RM/2015-3 (as from 1st January 2016).

        • BANK 5.3.4 Guidance [Deleted]

          Deleted by QFCRA RM/2015-3 (as from 1st January 2016).

      • BANK 5.3.5 Obligation to measure

        (1) A banking business firm must measure, classify and make provision for each large exposure individually.
        (2) The firm must immediately notify the Regulatory Authority if the firm is concerned that risk concentrations or large exposures might significantly affect its capital adequacy. The notice must describe the firm’s proposed measures to address its concerns.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

    • BANK Part 5.4 BANK Part 5.4 Powers of Regulatory Authority

      • BANK 5.4.1 Authority can create relationships

        If the Regulatory Authority considers it necessary or desirable to do so in the interest of effective supervision of a banking business firm, the authority may direct the firm to treat a party as connected to another party.

        Derived from QFCRA RM/2014-2 (as from 1st January 2015).

      • BANK 5.4.2 Authority can set different limits and ratios

        (1) Despite anything in these rules, the Regulatory Authority may, in writing, set specific limits on a banking business firm’s exposures to particular counterparties, groups of counterparties, industries, sectors, regions, countries or asset classes on a case-by-case basis.
        (2) If a banking business firm has 1 or more large exposures (excluding exposures to sovereigns and central banks) or if, in the Regulatory Authority’s opinion, the firm is exposed to a significant level of risk concentration, the authority may impose a higher capital ratio on the firm.
        (3) In considering whether to increase the firm’s capital ratio, the Regulatory Authority will take into account:
        (a) whether the increased capital ratio would be consistent with the firm’s concentration risk and large exposure policies;
        (b) the number of exposures, and the size and nature of each; and
        (c) the nature, scale and complexity of the firm’s business and the experience of its governing body and senior management.
        (4) The Regulatory Authority may also direct the firm to take measures to reduce its level of risk concentration.

        Note Under FSR, article 16, the Regulatory Authority may modify or waive the application of a prudential requirement to an authorised firm or firms.
        Derived from QFCRA RM/2014-2 (as from 1st January 2015).