GUIDELINES TO INCORPORATE MARKET RISK IN THE RISK-BASED CAPITAL ADEQUACY FRAMEWORK

1.  A new subsection is hereby added after Subsection X116.4 of the Manual to read as follows:

“§ I116.5.            Market Risk Capital Requirement. Universal banks (UBs)/commercial banks (KBs)
shall also measure and apply capital charges for market risk, in
addition to the credit risk capital requirement described above, in
accordance with the Guidelines to Incorporate Market Risk in the
Risk-Based Capital Adequacy Framework (Appendix __).”

2.  Subsections X116.5 and X116.6 of the Manual are hereby renumbered as Subsections X116.6 and X116.7, respectively.

3.  Subsection X116.6 of the Manual (formerly Subsection X116.5) is hereby amended to read as follows:

“§ X116.6.          Sanctions.
Whenever the capital accounts of a bank are deficient with respect to
the prescribed risk-based capital adequacy ratio (which for UBs/KBs
shall pertain to adjusted capital adequacy ratio covering combined
credit risk and market risk), the Monetary Board after considering a
report of the appropriate supervising and examining department of the
BSP on the state of solvency of the institution concerned, shall limit
or prohibit the distribution of the net profits and shall require that
part or all of net profits be used to increase the capital accounts of
the bank until the minimum requirement has been met.  The
Monetary Board may restrict or prohibit the making of new investments
of any sort by the bank, with the exception of purchases of readily
marketable evidences of indebtedness issued by the Philippine national
government and BSP included in Item a(2)i of Subsec. X116.2, until the minimum required capital ratio has been restored.”

This Circular shall take effect on July 1,
2003: Provided, That covered banks shall submit trial reports (solo
basis and consolidated basis) using the prescribed new report forms
commencing with the end-March 2003 reports.

Adopted: 3 Dec. 2002

(SGD.) AMANDO M. TETANGCO, JR.
Deputy Governor

Appendix I

GUIDELINES TO INCORPORATE MARKET RISK IN THE RISK-BASED CAPITAL ADEQUACY FRAMEWORK

Introduction

1.         These
guidelines describe the approach to be used by the BSP to determine the
minimum level of capital to be held by a bank against its market risk.  The
guidelines are broadly consistent with the recommendations of the Basel
Committee on Banking Supervision in a document entitled “Amendment to
the Capital Accord to Incorporate Market Risks” issued in January 1996.

2.         Under these
guidelines, banks shall be required to measure and apply capital charges
against their market risk, in addition to their credit risk.

3.         Market risk is defined as the risk of losses in on and off balance sheet positions arising from movements in market prices.  The risks addressed by these guidelines are:

– The risks pertaining to interest rate-related instruments and equities in the trading book; and

– Foreign exchange risk throughout the bank.

Coverage of capital requirement for market risk

4.         The capital requirement for market risk shall apply to all universal banks and commercial banks.

5.         The minimum
capital adequacy ratio covering combined credit risk and market risk
shall apply to banks which are subject to market risk capital
requirement on both solo basis (i.e., head office plus branches) and
consolidated basis (i.e., parent bank plus subsidiary financial allied
undertakings, but excluding insurance companies).

Methods of measuring market risk

6.         There are two alternative methods recognized for the measurement of market risk, as follows:

(a)     The
standardized approach shall be used by all banks which are subject to
market risk capital requirement, except by those which may be allowed by
BSP to use the alternative method described in paragraph (b) below.  The
method of measuring market risk under the standardized approach is set
out in the Instructions for Accomplishing the Report on Computation of
the Adjusted Risk-Based Capital Adequacy Ratio Covering Combined Credit
Risk and Market Risk.

(b)     The internal
models approach allows banks with the necessary system to use their own
internal risk management models to calculate market risk.  The use of this approach is subject to prior BSP approval.  Approval
shall be based on meeting certain qualitative and quantitative
conditions relating to the models themselves and the controls
surrounding them, as set out in Annex “A”.  Banks
may on a transitional basis be allowed to use a combination of the
standardized approach and the models approach to measure their market
risk, provided any such “partial” model shall cover a complete risk
category (e.g., interest rate risk or foreign exchange risk).  The
reporting under the internal models approach is contained in the
Instructions for Accomplishing the Report on Computation of the Adjusted
Risk-Based Capital Adequacy Ratio Covering Combined Credit Risk and
Market Risk.

Calculation of the capital adequacy ratio (CAR)

7.         The adjusted
capital adequacy ratio covering combined credit risk and market risk
shall be calculated using the qualifying capital expressed as a
percentage of the total risk-weighted assets (including credit risk and
market risk-weighted assets).  The components of this calculation are as follows:

– Market risk-weighted assets are
the sum of the capital charges for all market risk categories
calculated using either the standardized approach or the internal models
approach (multiplied by 125 percent for those calculated using the
standardized methodology to be consistent with the higher capital charge
for credit risk, i.e., 10 percent as opposed to BIS recommended 8
percent) multiplied by 10.  (The multiplier 10 is the reciprocal of the BSP required minimum capital adequacy ratio for credit risk of 10 percent.  The
effect is to convert the sum of the market risk capital charges into a
risk-weighted assets equivalent which can then be directly added to the
total credit risk-weighted assets.);

– Credit risk–weighted assets are
the total risk-weighted assets calculated in accordance with Subsection
X116.2 of the Manual of Regulations for Banks, less the part calculated
for on-balance sheet debt securities and equities in the trading book.  (The
credit risk-weighted assets for on-balance sheet debt securities and
equities are deducted because they represent an element now covered by
the market risk capital charge); and

– Qualifying capital is the same as that calculated in accordance with Subsection X116.1 of the Manual of Regulations for Banks.

8.         Banks shall
maintain a minimum adjusted risk-based capital adequacy ratio covering
combined credit risk and market risk of 10 percent calculated in this
manner on solo basis and on consolidated basis.

The trading book

9.         A key feature of the market risk framework is the definition of the trading book of a bank.  This
is set out in the Instructions for Accomplishing the Report on
Computation of the Adjusted Risk-Based Capital Adequacy Ratio Covering
Combined Credit Risk and Market Risk. Banks are expected to adopt a
consistent approach to allocating transactions into their trading and
non-trading (i.e., banking book), and clear audit trail for this purpose
should be created at the time each transaction is entered into.  The
BSP shall monitor banks’ practices to ensure that there is no abusive
switching between different books to inappropriately reduce capital
charges.

Required reports

10.       Banks shall
submit quarterly reports of their adjusted risk-based capital adequacy
ratio covering combined credit risk and market risk on solo basis and on
consolidated basis to the appropriate supervising and examining
department of the BSP in accordance with the attached prescribed forms
within 15 banking days and 30 banking days after the end of reference
quarter for solo report and consolidated report, respectively.  These
reports shall be in addition to the reports on risk-based capital
adequacy ratio covering credit risk required to be submitted in
Subsection X116.4 of the Manual of Regulations for Banks.

11.       One of three
alternative report forms, a copy each attached, shall be used depending
on the complexity of the bank’s operations, to wit:

(a)     For UBs/KBs with expanded derivatives authority;

(b)     For UBs/KBs with expanded derivatives authority but without option transactions; or

(c)     For UBs/KBs without expanded derivatives authority.

12.       The abovementioned reports shall be classified as category A-2 Reports.