September 22 , 2007
Circular BM – 1024
To
All Licensed Banks Operating in the Sultanate of Oman
Sub: Master Circular on Lending Limitations and Exposures to
Connected / Related Parties
1. Introduction
1.1 Diversification of risk is a key precept in banking. Experiences
indicate that substantial loan losses, sometimes leading to bank
failures, in the past, in many jurisdictions, were triggered by credit
concentrations to connected counterparties or related parties.
Besides individual exposures, credit concentrations also involve
over-exposure to sectors, industries, regions, countries, etc., which
too have implications for the risk profile of banks’ loan books. In this
context, supervisors across various jurisdictions, in the interest of
maintaining financial stability, set prudential limits and rules aimed
at limiting the potential losses arising out of excessive concentration
of credit risk on a stand alone basis and also including the
connected parties.
1.2 Core Principles for Effective Banking Supervision released by
the Basel Committee also requires supervisors to set prudential
limits to restrict bank exposures to single counterparties or groups
of connected counterparties. Further, in order to prevent abuses
arising from exposures to related parties and to address conflict of
interest, supervisors are required to put in place requirements that
banks extend exposures to related companies and individuals on
an arm’s length basis, these exposures are effectively monitored,
appropriate steps are taken to control or mitigate the risks and
write-offs of such exposures are made according to standard
policies and processes.
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1.3 As a prudential measure towards moderation of concentrated
credit risk, Articles 68 (b), (c) and (d) of the Banking Law 2000
place restrictions on banks’ exposure to a “person and his related
parties” (hereinafter referred to as “connected counterparty”) and
senior member in the management of banks and his related parties
(hereinafter referred to as “related party”), which were
supplemented with Regulations and Circulars. In the interest of
achieving greater transparency and consistency in prudential
regulations on such exposures, the following updated and
consolidated instructions, in supersession/modification of
instructions contained in the Regulations/ Circulars, as listed in
Attachment I, have been issued for strict compliance by licensed
banks. The set rules are aimed at preventing the banks from
assuming excessive credit risk, due to asset concentrations to
groups of connected counterparties and / or related parties.
2. Measure of Credit Exposure
2.1 The measure of credit exposure should encompass the
maximum amount of credit risk arising from both actual claims and
potential claims of all kinds. Thus, the measure of exposure should
include,
a) All Funded facilities;
b) The par (100%) values of credit substitutes, such as guarantees,
acceptances, letters of credit, and other transactions with
recourse, and all other forms of contingent liabilities, notably
credit commitments, which are not cancelable;
c) The credit equivalent amount used for determining regulatory
capital in respect of contracts and derivatives, such as forward
contracts, forward rate agreements, swaps, options, futures, etc,
where the lender is not exposed to credit risk for the full face
value of their contracts, but only to the potential cost of replacing
the cash flows (on contracts showing positive value) if the
counterparty defaults1.
1
Banks may refer to the Guidelines on International Convergence of Capital
Measurement and Capital Standards – A Revised Framework (Basel II) for arriving
at the credit equivalent amount in respect of derivatives.
2
Thus, the measure should reflect the maximum loss that could arise
should the counterparty fail or the loss that may arise in the
realization of any assets, or other exposures or off-balance sheet
positions.
2.2 Exposures shall also include investment exposure (investments,
underwriting commitments, etc). As a general rule, all exposures
shall be determined on a gross basis without netting credit risk
mitigants, loan loss provisions, and reserve interest. Further, the
authorized limits or outstandings, whichever are higher, shall be
reckoned for determining the exposures. However, in the case of
fully drawn term loans, where there is no scope for re-drawal of any
portion of the authorized limit, the outstanding amount could be
reckoned as credit exposure.
2.3 Bank’s exposure to securities trading operations shall be
calculated as its net long position in a particular security (a long
position in a security should not be netted off against a short
position in another issue of the same issuer). The net position in a
security refers to the commitment to buy a security together with its
current holding of the security, less its commitment to sell the
security.
2.4 The total exposure to a connected counterparty or a related
party shall be determined by aggregating the exposures computed
in terms of paragraphs 2.1, 2.2 and 2.3.
3. Definition of Connected Counterparty and Related Party
3.1 Proper identification of potential linkages between exposures to
banks’ counterparties is important for restricting credit
concentrations. It is quite possible that separate counterparties,
despite dealing on an independent basis with banks, represent a
single risk inasmuch as they are so interconnected legally or
economically with the likelihood that if one of them experiences
financial difficulties, the other or all of them are likely to encounter
problems. Thus, repayment difficulties could arise for all parties if
any one of them experienced financial problems. The relationship
should ideally, therefore include connection through close family
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relation/ common ownership / control, or management, crossguarantees and direct commercial interdependency which cannot
be substituted in the short-term.
3.2 In the Sultanate, the connected counterparty and related parties
are defined in Regulations 47 and 48/ 2/ 2000 respectively. While
the structure of the definition remains the same, some
modifications, as stated in paragraphs 3.3 and 3.6 have been made
to capture the full risk associated with lendings to connected
counterparty / related party.
Group of Connected Counterparties
3.3 Group of connected counterparties, as per international best
practices, shall be a group of persons and / or companies related
financially or by close family relation, common ownership,
management or any combination thereof constituting a single risk.
Further, two or more natural or juristic persons would be considered
as connected even if there is no relationship of control between
themselves, as indicated above, but who are regarded as
constituting a single risk, as they are so interconnected (captive
customers or suppliers) that, if one of them were to experience
financial problems, the others would likely encounter payment
difficulties.
3.4. Banks may assess a group of connected counterparties by
treating one of the connected counterparties as the ‘principal’ (who
is a natural or juristic person) and by determining other
counterparties with reference to the principal connected party. A
connected counterparty for compliance with this Circular thus may
comprise of:
i)
the ‘principal’ connected party (A natural or juristic
person);
ii)
Associates of the principal connected party, where the
associates shall include
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a)
b)
close member of the family i.e. parents,
spouses, sons and daughters, including
legal adoptions and
business entities wherein 25% or more of
the voting power is controlled individually
or collectively with the associates;
iii)
Associates of the principal connected party, where the
associates includes parent company, subsidiaries,
fellow subsidiaries and other business entities where the
concerned juristic person owns or controls either directly
or indirectly 25% or more of the voting power.
iv)
Persons or companies that have dependence
economically or operationally on the principal connected
party, as a major customer or supplier, which cannot be
substituted in the short-term.
Related Parties
3.5 As per international best practices, the related parties shall
include bank’s subsidiaries and affiliates, and any other parties that
the bank exerts control over or a party that exerts control over the
bank. It will also include the bank’s major shareholders, directors,
senior management and key staff, their direct and related interests,
and their close family members as well as corresponding persons in
affiliated companies.
3.6 The related parties for a bank, for compliance with this Circular,
would include:
i)
Chairman and Directors on the Boards, including proxy
Directors
ii)
Parent entities, subsidiaries, fellow subsidiaries of the
bank;
iii)
Chief Executive Officers and other line management –
Deputy Chief Executive, General Managers, Deputy
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General Managers, Assistant General Managers and
any other key management personnel (only those
having authority and responsibility for planning, directing
and controlling the activities of the bank, directly or
indirectly) who are reporting directly to the Board or the
CEO.
iv)
Any natural / juristic person who holds or controls,
directly or indirectly, 10% or more of the voting power of
the bank.
v)
An associate of any of the natural persons shall include
a)
close member of the family i.e. parents,
spouses, sons and daughters, including
legal adoptions and
b)
business entities wherein 25% or more of
the voting power is controlled individually
or collectively with the associates;
vi)
An associate of any juristic person shall include parent
company, subsidiaries, fellow subsidiaries and business
entities where the concerned juristic person controls
25% or more of the voting power. It shall also include
companies whose majority of the Directors acts as per
the wishes of the concerned company.
3.7 Banks may consider the above definitions as the minimum for
establishing linkages amongst the connected counterparties or
related parties. In real practice, it is possible that a few customers
may disguise linkages between two or more parts of the same
connected group. The banks should, therefore, strengthen their
surveillance mechanism in detecting subterfuges designed to
disguise relationships between borrowers.
4. Prudential Limits on Large Exposures
4.1 The international best practice on limiting large exposures
envisages that credit exposures are fixed in relation to banks’
capital funds, as defined under capital adequacy. The credit
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exposure limits in the Sultanate also are expressed in terms of the
banks’ total capital (Tier 1, Tier 2 and eligible Tier 3) or global net
worth2, as approved by the Central Bank.
a) The aggregate exposure to a connected counterparty
shall not at all times exceed 15% of the total capital of
the banks.
b) In the case of a related party, the total credit exposure
shall not at all times exceed 10% of the total capital and
that the aggregate of credit exposure to all the related
parties shall not exceed 35% of the banks’ total capital.
c) The aggregate exposures of overseas branches of
locally incorporated banks to a connected counterparty,
who is a resident in the respective countries of
operations, shall not exceed 5% of the total capital
(global net worth) or the single obligor legal lending
limitation imposed by the host supervisory authority,
whichever is less.
4.2 Exposures to related parties are justified only when undertaken
for the clear commercial advantage of the banks and extended on
an arm’s length basis. Thus, any exposures to the related parties, in
the nature of capital investments or made particularly at favourable
terms (not on arm’s length commercial basis) – with relaxation in
risk assessment, interest rates, amortization schedules,
requirement of collateral, etc., should be deducted from Tier 1
capital of banks. Banks are also precluded from lending to their own
external auditors or to any partners thereof or to any of the
employees of such audit firms.
4.3 Banks are generally not encouraged to assume exposures to
connected counterparties or related parties beyond the prudential
limits. The loan policy should delineate the philosophy and
approach on the management of credit concentration.
2
The term Global Net Worth has been defined in Master Circular on Net Worth (BM
988).
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5. Credit Risk Mitigants
The limitations on exposures to connected counter parties and
related parties shall not apply to:
a) Exposures secured in cash or in cash equivalent not
subject to withdrawal.
b) Exposures guaranteed, including by standby letters of
credit or warranties or participations or repurchases,
etc, in a manner satisfactory to the Central Bank, by a
bank or financial institution within or outside the
Sultanate
c) To the extent that the payment of the principal and
interest of such exposures have been guaranteed by
the Government of the Sultanate or any Ministry thereof.
d) Inter-bank exposures
e) Exposures arising from underwriting obligations, which
are held in the trading book.
6. Large Joint Venture Projects
6.1 Certain large projects, involving large outlay of funds are being
executed in the Sultanate in the core sector towards promoting the
overall development of the country. These projects are expected to
be self-supporting with high internal rate of return and are generally
managed professionally with substantial foreign collaboration
and/or investment. The amount involved in such projects is huge
and often involve substantial bank lending with some Government
participation. A special treatment for financing of such projects is
considered necessary in the context of their national importance
and low credit risk.
6.2 Accordingly, the proposals, which comply with the following
conditions, could be treated on a standalone basis, subject to
specific prior approval of the Central Bank, without aggregating with
the credit exposures of local groups or sponsors or
partners/promoters:
8
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
Significant shareholding by the Government of the
Sultanate of Oman and/or reputable international
bodies;
The projects should be in the core sector, such as
power, roads, telecommunication, seaports, airports,
industrial/knowledge parks, fishing, tourism, health,
education, water treatment, LNG, fertilizers and petrochemicals;
The projects should be viable, supported by strong cash
flows and financials;
The local partners’ equity stake in the project should not
exceed 49% of the total paid-up capital ;
The creditworthiness and/or default history of the local
partners should be satisfactory;
The overseas partners should have strong financials
and have sound experience in the proposed projects;
The maximum exposure per project should not exceed
15% of the net worth of banks; and
The maximum maturity of the loans should not exceed
15 years and should be financed out of long-term
sources of funds to avoid serious asset liability
mismatches.
6.3 Banks may approach the Central Bank with brief details about
the proposals, particularly shareholding pattern, technical expertise
of the foreign collaborator, projected cash flows and profitability,
bank’s risk assessments, etc., for seeking prior permission for not
aggregating the exposure to such projects with that of the local
partners/sponsors/promoters.
7. Exposures to Government Companies
7.1 The Government of the Sultanate has been promoting
companies, either as fully owned or majority or minority owned, in
green field projects like oil, gas, fertilizers and other downstream
projects. These companies serve in diversifying the economy and
also in generating employment opportunities.
9
7.2 Considering the significant role played by such companies in
the overall development of the economy and potentially lower credit
risk associated with such projects, the Central Bank shall consider,
on a case-by-case basis, the banks’ proposals to assume
exposures upto a maximum of 25% of their total capital, provided
the Government holds, either directly and/or indirectly, a minimum
of 25% of the shareholdings in such companies.
7.3 The additional exposures shall be allowed, on specific
references, with brief details about the proposals, particularly the
shareholding pattern, project specifics, projected cash flows and
profitability, banks’ risk assessment, etc., to the Central Bank. The
exposures to such counterparties that are in the core sector, as
indicated in para 6.2 need not be aggregated with the local
groups/partners/sponsors.
8. Exposures to SAOG Companies
In the normal course, exposures to connected counterparties /
related parties should be aggregated and the total exposures
should be within the prudential limits, as indicated in paragraph 4.
Considering the fact that SAOG companies are generally run on
professional lines and are more transparent in their operations, the
credit exposures to SAOG companies need not be aggregated with
the exposures of connected counterparties / related counterparties
and may be reckoned as a single risk, on a standalone basis.
However, the prudential limits, as relevant, should be applied, on a
standalone basis.
9. Substantial Exposure
9.1 The aggregate substantial exposure (i.e. credit exposure
individually of 10% or more of the total capital of the bank, on a
gross basis without adjusting for the credit risk mitigants, as
referred to in para. 5) to all the connected counterparties and all the
related parties shall not exceed 600% of the total capital of banks.
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9.2. Banks have no discretion in incurring credit exposures, in
excess of the above limits, without the prior permission of the
Central Bank.
10. Other Credit Concentrations
10.1 Apart from concentration of credit to counterparties, significant
exposure, particularly to economic sectors makes the banks
vulnerable to weakness in a particular industry/sector. Banks
should, therefore, systematically identify and measure their
exposures to different sectors, regions, countries, currencies, etc.,
and if necessary adjust the portfolio to moderate the risk profile.
The loan policy should stipulate prudential limits on exposures to
sectors/industry/region/country, having regard to the performance
of different sectors and the perceived risks, which may help banks
to evenly spread their exposures over various sectors. The risk
management policies and procedures should establish thresholds
for acceptable credit concentrations. The prudential limits may be
revisited at periodical intervals to capture evolving situations.
10.2 The large exposure limits are not applicable to the credit
exposures on other banks and banks are expected to put in place
appropriate exposure limits on individual banks, considering their
financial strength, rating etc. However, banks exposure in the form
of credit risk mitigants exacerbates the concentration problem.
Currently, banks have been extending guarantees, back to back
guarantees, standby letters of credit, warranties, participations,
repurchase agreements, etc., on behalf of their counterparties and
associates in Oman or overseas as credit risk mitigants against
credit facilities extended in excess of large exposure limits. In order
to avoid concentration of such credit risk mitigants, indemnifying
banks should limit such facilities to each beneficiary bank upto 25%
of the indemnifying bank’s total capital.
11. Indemnity Agreements
11.1 Any exposure in excess of the connected party exposure limits
of 15% and related party exposure limits of 10% of the total capital
could be covered by eligible collaterals, indemnity guarantee, back
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to back guarantees, standby letters of credit, warranties,
participation or repurchase agreements, etc obtained by banks,
acceptable to the Central Bank, as indicated in paragraph 5 (b).
11.2 It may be noted that guarantees/indemnities issued in favour
of a customer need to be aggregated along with any other facility
provided by the indemnifying bank to the same customer, for
adherence to the connected party or related party lending limits.
11.3 While the banks are primarily responsible for proper legal
documentation of the indemnity agreements or other credit risk
mitigants, the Central Bank has drawn up a proforma Indemnity
Agreement (Attachment – II), which provides the minimum essential
coverage for the use of banks. The banks are free to make suitable
changes/additions in consultation with their lawyers, to the
document. Banks should also exercise caution in proper execution
of the documents including thorough verification of signatories for
safeguarding their interests.
11.4 The aggregate amount of the indemnity and other risk
mitigants, covered by various agreements should not at all time
exceed 25% of the indemnifying/credit protection providing bank’s
total capital.
12. Reporting
Exposure to connected counterparties, in excess of 10% of the total
capital of a bank, without adjusting for the eligible collaterals and
other credit risk mitigants may be reported in the attached format
(Attachment – III), on a quarterly basis. Exposure to related parties
should be reported on a quarterly basis in the enclosed format
(Attachment – IV). Banks should also report, on a quarterly basis,
the indemnities and other risk mitigants issued / obtained, as per
Attachments V and VI.
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13. Senior Management Responsibilities
The Board of Directors are primarily responsible for monitoring
credit concentrations and devising such measures including
articulation of appropriate loan policies and loan review mechanism
for ensuring that the concentrations are well within the laid down
policies and regulatory requirements. The Board of Directors should
always endeavour for ensuring a balanced composition of their
bank’s loan book. The Board should also put in place appropriate
MIS to assess and manage credit concentrations on a timely basis.
Best regards,
Hamood Sangour Al-Zadjali
The Executive President
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Attachment - 1
Sl Details
No
1
Implementation
of
Article 4-4.05(b) & (c)
of Banking Law of
1974
Indemnity
Agreement format for
bank's use
2
Indemnity Agreements
3
-do4
-do5
-do6
-do7
Implementation
of
Royal
Decree
No.69/91 dated June
19, 1991 regarding
licensed Banks' Legal
Lending Limitations
8
-do9
-do10 Implementation
of
Royal
Decree
No.69/91 dated June
19, 1991 regarding
licensed Banks' Legal
Lending Limitations
11 Regulation
No.BM/REG/47/2/2000
Lending Limitations of
Licensed Banks
12 Regulation
No.BM/REG/48/2/2000
on Lending Limits to
Senior Members in the
Management of the
Bank
13 Extension of Credit
Facilities by Locally
incorporated licensed
banks in the Sultanate
of Oman and/or their
Circular No.
BM 381
Date of the Remarks
Circular
11/09/1983 Superceded
BM 589
BM 827
BM 862
BM 914
BM 918
BM 626
02/01/1991
17/11/1997
10/01/1999
23/05/2001
17/09/2001
02/10/1991
Superceded
Superceded
Superceded
Superceded
Superceded
Consolidated
BED GEN 91 555 10/11/1991 Consolidated
BED GEN 91 707 28/01/1992 Consolidated
BED GEN 92 276 12/05/1992 Superceded
BM REG 47 2 19/04/2000 Consolidated;
2000 (Refer BM
continues to
888)
be valid.
BM REG 48 2 19/04/2000 -do2000 (Refer BM
889)
BM 930
29/01/2002 Consolidated;
14
Sl Details
No
Overseas Branches
14 Lending Limitations of
Licensed Banks
15 Lending Limitations of
Licensed Banks
16 Amendments to Article
4-4.05 on Borrowing
and
Lending
Limitations of Licensed
Banks.
17 Clarification of the
term "Person"
18 BM/REG/30/9/88
Regulation on Lending
Limits
to
Senior
Members
in
the
Management of the
Bank
19 Implementation
Procedure
Regulation on Lending
Limits
to
Senior
Members
in
the
Management of the
Bank
BM/REG/30/9/88
20 Implementation
Procedure
BM/REG/30/9/88
Regulation on Lending
Limits
to
Senior
Members
in
the
Management of the
Bank
21 Extension of credit
facilities to banks’
external auditors and
their employees
22 Lending
to
Nonresidents
and
Placements of Bank
Funds abroad
Circular No.
Date of the Remarks
Circular
BSD 2002 BKUP 13/02/2002 Consolidated;
BANKS 097
BM 939
16/06/2002 Consolidated;
BM 371
26/04/1983 Superceded
BM 407
08/01/1985 Superceded
BM 518
16/10/1988 Superceded
BCD BES GEN 15/01/1989 Superceded
88 184
BCD IFS CB 89 17/10/1989 Superceded
671
BM 646
3/3/1992
BSD/2006/BKUP/ 29/8/2006
Local Banks/ 760
Consolidated
Consolidated
15