cooke methodology

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COMMISSION BANCAIRE

General Secretariat

Office of International Affairs Paris, February 13, 2004

METHODS FOR CALCULATINGINTERNATIONAL CAPITAL ADEQUACY RATIOS

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Update of January 1, 20041

1 For further information regarding this document, contact the Office of International Affairs by telephone at 01.42.92.60.34,01.42.92.57.35, or 01.42.92.57.00, or by fax at 01.42.92.20.15. Methods for Calculating International Capital AdequacyRatios can also be consulted on the Internet page of the Banque de France, www.banque-france.fr, under the headingBanking and Financial Information / Banking and Financial Supervision / Basel Committee. It is also available, along withthe text of all banking regulations issued since January 1, 1999, on the Internet site of the Commission Bancaire,www.commission-bancaire.org.


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METHODS FOR CALCULATING INTERNATIONAL CAPITAL ADEQUACY RATIOS, 01/01/2004

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Since January 1, 1998, internationally active French credit institutions2 have been required tomeasure the market risk to which they are exposed and to apply minimum capital adequacyrequirements, as they were already required to do for their credit risk. The international requirementsrelating to market risk (laid out in Amendment to the Capital Accord to Incorporate Market Risks,published by the Basel Committee in January 1996) were incorporated in the November 1997 editionof this Notice. The provisions relating to the calculation of capital requirements for credit risk areupdated in this Notice. 3

It should be recalled that, since it is possible to calculate the capital ratio before the allocationof profits and losses has been given final approval at the annual meeting of stockholders, the due datefor submitting reports concerning capital adequacy ratios to the Secrtariat Gnral de la Commission

Bancaire is set at three months after the closing of the annual or semi-annual accounts. Institutionssubject to these requirements are thus required to submit two sets of reports each year, on the

basis of their accounts as of June 30 and December 31.

2 Internationally active credit institutions are defined as those institutions :

having subsidiaries or branches outside France and/or,

whose transactions in foreign currencies with residents and foreigners, combined with their transactions in euros withnon-residents, amount to more than one third of their total consolidated balance sheet.

Of course, any other credit institution may adopt the international capital adequacy framework voluntarily if it judges thisto be conducive to the development of its activities.

3 Paragraphs that have been added or modified are underlined.


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INDEX

1. DEFINITIONS................................................................ ........................................................... .......... 7

1.1. MARKET RISK.................................................... ........................................................... .................... 71.2. THE TRADING BOOK .................................................... ........................................................... .......... 71.3. METHODS FOR MEASURING MARKET RISK........................................................... .............................. 71.4. OVERALL MINIMUM CAPITAL REQUIREMENTS ..................................................... .............................. 81.5. DEFINITION OF CAPITAL AND COVERAGE OF MARKET RISK...................................................... .......... 81.6. CALCULATING THE CAPITAL RATIO ........................................................... ........................................ 8

2. THE CONSTITUENTS OF CAPITAL..................................................... ........................................ 8

2.1. CORE CAPITAL ( TIER 1 ) .................................................... ........................................................... 92.2. SUPPLEMENTARY CAPITAL ("TIER 2")...................................... ....................................................... 10

2.2.1. Upper Tier 2 Capital ............................................................................................................ 102.2.2. Lower Tier 2 Capital ............................................................................................................ 11

2.3. DEDUCTION OF PARTICIPATIONS .................................................... ................................................ 12

2.4. TIER 3 CAPITAL .......................................................... ........................................................... ........ 133. RISK WEIGHTING OF ASSETS AND OFF-BALANCE SHEET EXPOSURES .................... 13

3.1. ON-BALANCE SHEET EXPOSURES .................................................... ................................................ 133.1.1. Exposures risk weighted at 0%............................................................................................. 133.1.2. Exposures risk weighted at 20%........................................................................................... 143.1.3. Exposures risk weighted at 50%........................................................................................... 153.1.4. Exposures risk weighted at 100%......................................................................................... 163.1.5. On-balance sheet netting...................................................................................................... 163.1.6. Additional details.................................................................................................................. 18

3.1.6.1. Amount of claims to be taken into account .................................................................................183.1.6.2. Amount of claims to be included in exposures............................................................................. 183.1.6.3. Collateral ...................................................................................................................................183.1.6.4. Guarantees .................................................................................................................................163.1.6.5. Securitisations............................................................................................................................193.1.6.6. Securities held as assets..............................................................................................................203.1.6.7. Shares in UCITs and ordinary shares in FCCs.............................................................................203.1.6.8. Repurchase agreements ..............................................................................................................203.1.6.9. Securities lending and borrowing................................................................................................213.1.6.10. Temporary sales of securities (repurchase agreements, securities lending and borrowing and

securities received in repurchase agreements)............................................................................213.1.6.11. Sales with repurchase options....................................................................................................223.1.6.12. Guarantee deposits and contributions to Clearnet clearing fund................................................. 223.1.6.13. Option premiums.......................................................................................................................223.1.6.14. Special cases .............................................................................................................................23

3.2. OFF-BALANCE SHEET EXPOSURES .................................................. ................................................ 233.2.1. Off-balance sheet exposures, excluding derivative instruments ..................................... ..... 243.2.1.1. Instruments for which the credit conversion factor is 100% .........................................................243.2.1.2. Instruments for which the credit conversion factor is 50% ...........................................................243.2.1.3. Instruments for which the credit conversion factor is 20% ...........................................................253.2.1.4. Instruments for which the credit conversion factor is 0% ........ ......... ........ ........ ......... ........ ......... ..25

3.2.2. Off-balance sheet exposures in the form of derivative instruments. .................................... 263.2.2.1. Measurement of gross exposure .................................................................................................. 263.2.2.2. Netting........................................................................................................................................ 293.2.2.3. Assets collateralising derivative transactions................................................................................313.2.2.4. Special cases ...............................................................................................................................32

4. CAPITAL REQUIREMENTS FOR MARKET RISK ................................................ .................. 32

4.1. THE STANDARDISED APPROACH ..................................................... ................................................ 334.2. THE INTERNAL MODELS APPROACH.......................................................... ...................................... 33


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5. METHODS FOR CALCULATING AND APPLYING THE RATIO ......................................... 33

5.1. MINIMUM STANDARDS RELATING TO THE RATIO AND CAPITAL ....................................................... 335.2. DENOMINATOR OF THE RATIO ........................................................ ................................................ 345.3. NUMERATOR OF THE RATIO................................................... ......................................................... 345.4. RULES OF CALCULATION....................................................... ......................................................... 34

ANNEX 1 - CALCULATING NET POSITIONS............................................................................... 37

1. PRINCIPLES........................................................... .......................................................... .................. 37

2. INCLUSION OF FORWARD POSITIONS AND OPTIONS .................................................... ........ 37

3. SPECIAL CASES............................................................ ............................................................ ........ 39

ANNEX 2 - INTEREST RATE RISK............................ ...................................................................... 40

1. SPECIFIC RISK...................................................... ........................................................... ................. 40

2. GENERAL RISK.................................................... ........................................................... .................. 41

2.1. FOR EACH CURRENCY, CALCULATE THE CAPITAL REQUIREMENT FOR THE NET POSITIONS DEFINEDIN ANNEX 1....................................................... ........................................................... .................. 42

2.2. FOR EACH CURRENCY, CALCULATE THE ADDITIONAL CAPITAL REQUIREMENT FOR OPTION RISKUSING THEMETHODS OF ANNEX 6................................................... ................................................ 42

2.2.1. Maturity method ................................................................................................................... 422.2.2. Duration method................................................................................................................... 452.2.3. Use of a sensitivity algorithm............................................................................................... 47

ANNEX 3 - EQUITY-POSITION RISK ............................................................................................. 48

1 - GENERAL RISK .................................................. ........................................................... .................. 48

2 - SPECIFIC RISK.......................................... ................................................................ ....................... 48

3. ARBITRAGE BETWEEN SPOT AND FORWARD POSITIONS .................................................... 49

ANNEX 4 - FOREIGN EXCHANGE RISK ....................................................................................... 50

1. CALCULATING THE OVERALL NET POSITION...... ........................................................... ........ 50

1.1. STAGE 1............................................................ ........................................................... .................. 501.1.1. Items included....................................................................................................................... 501.1.2. Items excluded ....................................................... ....................................................... ........ 511.1.3. Use of present value ............................................................................................................. 511.1.4. Gold position .............................................. ................................................ .......................... 51

1.2. STAGE 2............................................................ ........................................................... .................. 512. CALCULATING CAPITAL REQUIREMENTS................................................................................ 51

ANNEX 5 - COMMODITIES RISK ................................................................................................... 52

1. CALCULATING POSITIONS................................................... ......................................................... 52

1.1. GENERAL RULES ......................................................... ........................................................... ........ 521.2. SPECIAL RULES FOR DERIVATIVE PRODUCTS ....................................................... ............................ 521.3. FINANCING POSITIONS .......................................................... ......................................................... 531.4. MATURITY TABLE AND SPREAD RATES ..................................................... ...................................... 53

2. CALCULATING CAPITAL REQUIREMENTS................................................................................ 53

2.1. MATURITY TABLE METHOD................................................... ......................................................... 532.2. SIMPLIFIED APPROACH .......................................................... ......................................................... 54


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ANNEX 6 - OPTION RISK ....................................................................... ........................................... 55

1. DELTA PLUS METHOD ........................................................... ........................................................ 55

2. SCENARIO ANALYSIS............................................................. ........................................................ 56

3. SIMPLIFIED METHOD ............................................................ ......................................................... 57

ANNEX 7 - USE OF INTERNAL MODELS IN CALCULATING

CAPITAL REQUIREMENTS ..................................................... ........................................................ 59

1. PRINCIPLES........................................................... .......................................................... .................. 59

2. QUALITATIVE CRITERIA...................................................... ......................................................... 59

3. SPECIFICATION OF MARKET RISK FACTORS........................................................... ................ 61

4. TREATMENT OF SPECIFIC RISK............................ ................................................................ ....... 62

5. QUANTITATIVE CRITERIA................................................... ......................................................... 62

6. STRESS TESTING .......................................................... ........................................................... ........ 63

7. COMBINED USE OF INTERNAL MODELS AND THE STANDARDISED APPROACH............ 64

8. BACK-TESTING............................................................... ......................................................... ........ 64

9. CALCULATING CAPITAL REQUIREMENTS................................................................................ 64

ANNEX 8 - LIST OF OECD GROUP COUNTRIES ........................................................................ 67

ANNEX 9 - LIST OF PUBLIC-SECTOR GUARANTEE AGENCIES AND

PUBLIC-SECTOR EXPORT-INSURANCE AGENCIES

LOCATED IN OECD GROUP COUNTRIES ................................................... ......... 68

1. LIST OF FRENCH PUBLIC-SECTOR AGENCIESAUTHORISED TO GIVE GUARANTEES ..................................................................... ................ 68

2. LIST OF PUBLIC-SECTOR EXPORT INSURANCE AGENCIESIN OECD GROUP COUNTRIES ..................................................................................................... 69

ANNEX 10 - LIST OF FRENCH AGENCIES TREATED AS PART OF

THE CENTRAL GOVERNMENT OR CENTRAL BANK....................................... 71

ANNEX 11 - REGIONAL AND LOCAL AUTHORITIES RISK-WEIGHTED AT 0% .............. 73

ANNEX 12 - LIST OF MISCELLANEOUS LOCAL FRENCH

ADMINISTRATIVE BODIES RISK WEIGHTED AT 20% .................................... 75

ANNEX 13 - LIST OF MULTILATERAL DEVELOPMENT BANKS RISK WEIGHTED AT

20% ..................................................... ........................................................... .................. 78

ANNEX 14 - LIST OF STOCKS CONSIDERED SUFFICIENTLY LIQUID AND INDEXES

JUDGED BROADLY DIVERSIFIED................................................................. ......... 79

ANNEX 15 - PRUDENTIAL TREATMENT OF CREDIT DERIVATIVES ................................. 81

1. CRITERIA FOR CLASSIFICATION OF CREDIT DERIVATIVES IN THE TRADING

BOOK OR THE BANKING BOOK................................. ........................................................... ........ 81

1.1. CLASSIFICATION IN THE TRADING BOOK ................................................... ...................................... 81


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1.2. CLASSIFICATION IN THE BANKING BOOK ................................................... ...................................... 82

2. TREATMENT OF CREDIT DERIVATIES IN THE BANKING BOOK.......................................... 83

2.1. TREATMENT OF RISK FOR THE SELLER OF PROTECTION ........................................................... ........ 832.2. TREATMENT OF RISK FOR THE BUYER OF PROTECTION.................................................. .................. 83

2.2.1. Maturity mismatch................................................................................................................ 84

2.2.2. Basis and currency mismatch............................................................................................... 853. TREATMENT OF CREDIT DERIVATIES IN THE TRADING BOOK........... ............................... 85

3.1. GENERAL AND SPECIFIC RISK ......................................................... ................................................ 853.2. COUNTERPARTY RISK ........................................................... ......................................................... 863.2. LIQUIDITY AND MODELLING RISK................................................... ................................................ 86

ANNEX 16 - LIST OF MASTER AGREEMENTS WHICH PERMIT

PRUDENTIAL RECOGNITION OF NETTING........................................................ 87

1. NATIONAL MASTER AGREEMENT....................................................... ................................................ 872. INTERNATIONAL MASTER AGREEMENTS ...................................................... ...................................... 87

ANNEX 17 - PRESS RELEASE ISSUED BY THE BASEL COMMITTEE

ON OCTOBER 27, 1998 : INSTRUMENTS ELIGIBLE

FOR INCLUSION IN TIER 1 CAPITAL............... ................................................ ..... 88

ANNEX 18 - PRUDENTIAL TREATMENT OF SECURITISATION TRANSACTIONS ........... 91

1. PRINCIPLES .......................................................... ........................................................... .................. 922. METHODS OF APPLICATION....................................................... ......................................................... 93


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1. DEFINITIONS

1.1. Market risk

Market risk, defined as the risk of loss on on-balance sheet or off-balance sheet positionsarising from fluctuations in market prices, covers :

Risks pertaining to interest rate-related instruments and equity positions in the tradingbook ;

Foreign exchange risk and commodities risk arising from all on- and off-balance sheetactivities

1.2. The trading book

For the purposes of this Notice, the trading book consists of the elements listed in article 6 ofregulation 95-02, as amended by regulation 99-01 of June, 1999.

Temporary sales of securities and repurchase agreements in the trading book are included inthe calculation of general market risk. They are excluded from the scope of specific market risk, butcontinue to be fall within the scope of the capital adequacy requirements for credit risk set by the 1988Capital Accord.

The Secrtariat Gnral de la Commission Bancaire will pay particular attention to theeconomic substance of transactions assigned to the trading book, and to the continuity in the methodsused to decide which financial instruments belong in the trading book. There should be a accurate andexhaustive audit trail which makes it possible to verify that the criteria for apportionment between theportfolios have been respected.

In this connection, the General Secretariat of the Commission Bancaire reminds creditinstitutions that, in order to be placed in the trading book, positions must have been taken either fortrading purposes, or to hedge other positions in the institutions trading book. In either case, themarketability of the instruments used must be well established. Furthermore, the institution must have

the means and the experience for ensuring the active management of its trading positions, as well asadequate systems of internal control. The Secrtariat Gnral de la Commission Bancaire reserves theright to reclassify to the banking book any elements whose marketability becomes doubtful; forexample if there is a shortage of liquidity or an absence of genuine trading in the instrument inquestion, a fortiori if the average holding period for the instruments is longer than is consistent with ashort-term trading intent.

1.3. Methods for measuring market risk

Capital requirements for market risk apply on a consolidated basis in the same way as for creditrisk. Banks can choose between two broad categories of methods for measuring their market risks,

subject to the approval of the Secrtariat Gnrale de la Commission Bancaire :


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The first approach consists of standardised methods for measuring risks, using themechanisms set forth in Section 4.1.

The other approach, referred to as internal models is set forth in Section 4.2. The use ofthis approach is subject to certain conditions and requires the explicit approval of the Secrtariat

Gnral de la Commission Bancaire, It permits banks to rely on risk measures obtained from their owninternal risk management models, provided the bank satisfies qualitative and quantitative conditionsstated in Annex 7.

1.4. Overall minimum capital requirement

The overall minimum capital requirement is composed of :

a) the requirements for credit risk set forth in the 1988 Basel Accord, calculated excluding debtand equity securities held in the trading book and all positions in commodities, but including 4

counterparty risk on all over-the-counter derivative products in both the trading and banking books. ;

plus the requirements for market risk :

b) either the arithmetic sum of the capital requirements for market risk described in Section4.1 ;

c) or the capital requirements obtained from the modelling approach described in Section 4.2 ;

d) or a combination of b) and c) summed arithmetically.

1.5. Definition of capital and coverage of market risk

The principal forms of capital accepted for covering market risk are core capital andsupplementary capital, as those terms are defined in the 1988 Accord, and in such amounts as remainavailable after the capital requirements for credit risk have been covered. A third form of capital, Tier 3capital (defined in Section 2.4), consists of short-term subordinated debt and, may be used only tocover a portion of banks capital requirements for market risk. The conditions for its eligibility are setforth in Part 5 of this Notice.

1.6. Calculating the capital ratio

The capital ratio represents the capital available to cover both credit risk and market risk. If a

bank disposes of eligible Tier 3 capital which is not being used to cover market risk, it may report thatexcess as unused but eligible Tier 3 capital alongside its standard ratio.

2. THE CONSTITUENTS OF CAPITAL

It is important to distinguish between core capital and supplementary capital, some deductionsfrom capital being deducted entirely from core capital, and others from total capital..

4 or, more precisely, "continuing to include", these risks are already included in the calculation of credit risk andcounterparty risk under the 1988 Accord.


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2.1. Core Capital (Tier 1)5

Core capital (Tier 1) includes :

ordinary shares/common stock and certificates of investment,

non-cumulative preferred shares (Article L228-11 of the Code de Commerce) and preferredcertificates of investment, excluding preferred shares without voting rights (Article L228-12),

deeply subordinated notes issued under the conditions set in the article L.228-97 of the Codede Commerce, revised by the Financial Security Law dated August 1, 2003, with the priorconsent of the Secrtariat Gnral de la Commission Bancaire and provided that these notesmeet the eligibility criteria for Tier 1 as defined in Annex 17,

consolidated reserves (excluding revaluation reserves),

retained earnings,

undistributed earnings (if not yet approved by the general shareholders meeting),

positive goodwill

differences arising from consolidation by the equity method,

minority interests

positive foreign currency translation reserves,

Reserve for general banking risks (fonds pour risques bancaires gnraux) as defined in the

Governors agreement of November 6, 1991.

The following elements are deducted from Core Capital :

holdings of own shares 6,

the unpaid portion of capital,

accumulated losses,

formation expenses,

intangible assets (excluding leaseholds),

negative goodwill

minority interests in loss-making units,

negative foreign currency translation reserves

5 In accordance with the 27 October 1998 press release issued by the Basel Committee on instruments eligible for Tier 1,reproduced in French in Annex 17, certain innovative products may be included in core capital subject to the priorapproval of the Secrtariat Gnrale de la Commission Bancaire.

6 At their accounting value.


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2.2. Supplementary Capital (Tier 2)

Supplementary capital may be included only up to the limit of 100% of core capital.

A distinction is drawn between upper Tier 2 capital and lower Tier 2 capital.

The following elements may be included in supplementary capital :

2.2.1. UPPER TIER 2 CAPITAL

revaluation reserves ;

unrealised gains on holdings of marketable securities. A discount of 55% is applied, line byline, to the difference between the market price of the securities and their price of acquisition,in order to take into account the potential volatility of share prices and the notional tax chargeon gains ;

general provisions 7 ; general provisions not held against materialised and measurable lossesmay be included in supplementary capital up to a limit of 1,25% of risk-weighted assets 8 ;

guarantee funds, under the conditions set in Regulation n 90-02 of the Comit de laRglementation Bancaire ;

hybrid capital instruments 9 (including subordinated bonds which are convertible or redeemableonly in shares) that meet the following four conditions :

they are subordinated 10 in capital and interest and are fully paid up,

they are perpetual and cannot be redeemed except at the initiative of the issuer and withthe prior consent of the Secrtariat Gnral de la Commission Bancaire 11. Under nocircumstances should a request for redemption be made before a period of five years haselapsed, unless the redeemed borrowings are replaced with capital of equal or betterquality.

they include a clause giving the borrower the right to defer the payment of interest in theevent that the profitability of the banks renders their payment inadvisable 12,

7 Provisions on the liability side of the balance sheet and which are taken against probable losses or charges are deducted

from the corresponding exposures. For country risk provisions, the 1991 Governors Accord, also referred to as theAccord on cleaning provisions, has applied since 31 December 1993.

8 (See letter from Governor de Larosire to the chairman of the AFEC dated 7 March 1991, published in Bulletin n 4 of theCommission Bancaire).

9 Institutions should include a list of these instruments in an annex to the table of capital ratio calculations.

10 The requirement that instruments be subordinated precludes them in particular from having "negative pledge" clauses, asnoted in Bulletin n 13 of the Commission Bancaire.

11 The Secrtariat Gnral de la Commission Bancaire will grant approval if the redemption is at the initiative of the issuer,the redemption will not affect the solvency of the institution, and new instruments of lower quality are not issued at thesame time as the redemption.

12 If the payment of interest is deferred, the payment of interest not paid on its normal due date cannot take place before thenext date on which interest is due.


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they are available to cover losses without the bank being obliged to cease operations.

Methodological details for hybrid capital instruments

All perpetual subordinated debt issued prior to December 31, 1998 is included in upper Tier 2capital, subject to the ceiling mentioned above. For new issuances, the debt contracts should besubmitted for approval by the Secrtariat Gnral de la Commission Bancaire.

When a hybrid instrument or an instrument of higher quality is part of a financing whosestructure makes it impossible to determine with certainty if the instrument is perpetual, the instrumentis classified as term subordinated debt. This policy, adopted by the Basel Committee on May 26, 1989,does not apply to instruments issued prior to that date.

When a perpetual subordinated debt instrument incorporates a clause providing for progressiveescalation in the interest rate (TSIP or perpetual subordinated debt with interest step-up), therecognition of the perpetual character of the instrument depends on limits placed on the step-ups. Thefollowing cumulative limits apply, subject to approval by the Secrtariat Gnral de la Commission

Bancaire on a case-by-case basis : The interest rate cannot increase by more than 75 basis points at a time ;

The increase cannot exceed 75 basis points in a five-year period ; however the combination oftwo five-year periods is acceptable, yielding a maximum increase of 150 basis points in thetenth year of the borrowing.

The interest rate cannot be more than 250 basis points above the yield on a government bond.

These limits are computed in terms of the market conditions prevailing at the time of issuance.If the reference rate changes, the size of the step-up is measured by combining the spread over the

variable rate to which it is indexed (PIBOR, LIBOR, or similar reference rate) with the swap ratequoted at the time of issuance between that reference rate and the initial reference rate.

2.2.2. LOWER TIER 2 CAPITAL

This category includes term subordinated debt instruments 13 whose initial maturity is greaterthan or equal to five years, with the application of a annual amortisation once the residual life of theinstrument falls below five years. Early redemption of these instruments is permitted, with the approvalof the Secrtariat Gnral de la Commission Bancaire. However, under no circumstances should arequest for redemption be made before a period of five years has elapsed, unless the redeemedborrowings are replaced with capital of equal or better quality. Furthermore, redemption must notoccasion payment of compensatory indemnification by the borrower.

Subordinated debt that is convertible to or redeemable in shares or cash is treated as equivalentto shares or cash.

For the rate of amortisation in the last five years of a subordinated debt instrument, two casesare possible. For instruments that are redeemed in full at maturity, the amortisation is set at 20% peryear. For instruments that are redeemed on a predetermined annual schedule, the security orsubordinated loan is broken down into as many pieces as there are redemption dates and a lineardiscount of 20% per year is applied to each piece.

13 See note at the bottom of the following page.


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To illustrate the latter case,take the example of a subordinatedloan in the amount of 1 MEUR withan initial maturity of 10 years andredemption of half the principal after

7 years. The amount included incapital is indicated in the diagram. Inthis example, at the end of six yearsthe amount of the loan included incapital is 20% of 500,000 plus 80%of 500,000 = 0,5 MEUR. In otherwords, the discount is 50% in theseventh year.

The preceding limits on step-ups, which apply to perpetual hybrid capital instruments, arereduced in the case of term subordinated debt to 50 basis points per adjustment and per period of fiveyears, without the option of combining two five-year periods. When the step-up is greater than 50 basis

points, the date of the step-up is considered as the final maturity of the loan for purposes of calculatingthe discount. In addition, the yield must not be more than 250 basis points higher than the referencerate used.

Capitalised interest on subordinated debt is eligible for inclusion in lower Tier 2 capital,provided that it has the same degree of subordination as principal on the debt and that the period ofcapitalisation is at least five years. Capitalised interest is subject to a prudential discount of 20% peryear in the last four years of the period of capitalisation.

All of the instruments in this category of subordinated debt may be included in capital only upto the limit of 50% of the amount of core capital.

2.3. Deduction of participations

After applying the respective ceilings, the following investments in the capital (or itsequivalent) of credit institutions or investment firms 14 must be deducted from total core capital andtotal supplementary capital :

Loans made, and participating notes and subordinated debt issued by credit institutions 15 16,or investment firms.

Shares, preference shares, and parts sociales issued by credit institutions or investmentfirms.

Deeply subordinated notes issued by credit institutions or investment firms.

Guarantees provided in securitisation transactions as defined in Regulation n93-06 of theComit de la Rglementation Bancaire (see Section 3.1.6.5).

14 The deduction applies to all securities constituting capital (or equivalent) of credit institutions or investment firms, evenwhen they carry a guarantee provided by a third party. (See Bulletin de la Commission Bancaire n 9).

15 The amount of term subordinated debt to be deducted is calculated after applying the cumulative annual discount when theremaining maturity falls below five years. The amount corresponding to the discount must be recorded as exposures risk-weighted at 100% and included in the denominator of the ratio.

16 Including participating notes and subordinated debt issued and then repurchased by the institution.


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2.4. Tier 3 capital

Tier 3 capital consists of subordinated loans whose initial maturity is greater than two years,which do not carry guarantees, and which satisfy the following conditions :

the loan must be fully paid out, and the loan contract must provide that the loan cannot beredeemed before the agreed maturity without the approval of the Secrtariat Gnral de laCommission Bancaire ;

neither interest nor principal on these subordinated loans may be paid if it would result in theinstitution no longer satisfying its minimum capital requirement.

Upper Tier 2 capital that is above the ceiling applied in calculating capital requirements forcredit risk is eligible without restriction for inclusion in Tier 3 capital. Lower Tier 2 capital that isabove the ceiling applied in calculating capital requirements for credit risk is eligible only if it strictlysatisfies the conditions stated above. Furthermore, the amortised portion of lower Tier 2 capitaldiscounted its the last five years may not be included in Tier 3 capital.

Tier 3 capital may be used to cover market risk within certain limits, as set forth in Part 5 ofthis Notice.

3. RISK WEIGHTING OF ASSETS AND OFF-BALANCE SHEETEXPOSURES

The framework for measuring credit risk set forth in this section does not apply to debt andequity securities held in the trading book. It does apply to over-the-counter derivative instruments,temporary sales of securities and inter-bank transactions, even when they fall within the trading bookfor the calculation of market risk.

3.1. On-balance sheet exposures

3.1.1. EXPOSURES RISK-WEIGHTED AT 0%

Cash.

Claims 17 on central governments 18 and central banks of OECD Group countries 19, on theEuropean Communities (ECSC, EC, EURATOM) and on the institutions by prescribed treaty

(European Commission, ECJ).

Claims 17 on (or guaranteed directly by) central governments and central banks of countriesthat do not belong to the OECD Group, if denominated in their national currency and financedin the same currency.

17 Taking the form of loans or securities. For a given counterparty, the risk-weighting of off-balance sheet exposures isidentical.

18 See Annex 10 for a list of French agencies treated as part of the central government or central bank.

19 See Annex 8 for the composition of the OECD Group.


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Claims 17 guaranteed directly by (or collateralised by securities issued by) central governmentsor central banks of OECD Group countries or by the European communities, or guaranteed bypublic sector agencies authorised to give their guarantee 20.

Claims on Public Sector Entities (PSEs) which are not part of the central government butwhich are assigned a preferential risk weight of 0% by the supervisory authority of the countryin which they are located, provided that the country belongs to the OECD Group 21.

Claims 17 collateralised by cash or certificates of deposit issued by and deposited at the lendingbank.


Claims 17 on regional and local authorities of OECD Group countries 22, claims on institutionsnot of an industrial or commercial nature over which public authorities exercise control, eitherthrough capital holdings or through the nomination of managers, and claims on miscellaneousadministrative bodies listed in Annex 12.

Claims 17 guaranteed directly by, or collateralised with securities issued by regional or localauthorities of OECD Group countries 16.

Claims 17 on the multilateral development banks listed in Annex 13, and claims guaranteeddirectly by them or collateralised with securities issued by them.

Claims 17 on credit institutions 23 and investment firms 24 whose headquarters are located in anOECD Group country and on financial companies as that term is defined in Council Directive

20 See Annex 9 for a list of these agencies.

21 To preserve competitive equality and in accordance with the decision published by the Basel Committee on September 21,2001, claims on these entities may henceforth be risk-weighted at 0% (or 10% in certain cases) if the entities are assignedthat risk weight by the OECD authorities responsible their supervision. This rule extends the decision taken in July 2001for the Province of Quebec to all member countries of the OECD.

22 Claims on or guaranteed by regional and local authorities of a member State of the European Economic Area (EEA) maybe assigned a risk weight of 0% if that member State has authorised its credit institutions to apply a 0% risk weight tothose claims. See Annex 11 for a list of regional and local authorities in EU countries that are risk-weighted at 0%. Note,however, that when the guarantee takes the form of collateralisation with securities issued by such authorities, the riskweight may not be lower than 20%.

23 For institutions having their headquarters outside France, credit institution means any institution whose usual business iscarrying out banking transactions and which is subject to supervision by a bank regulatory agency. A list of creditinstitutions authorised in the European Union is published in the Official Journal of the European Communities (OJEC ofDecember 20, 1999)

24 Claims on investment firms authorised by the competent authorities in a Member State of the European Union or inanother State that is party to the Agreement on the European Economic Area are automatically risk-weighted at 20%.Claims on investment firms authorised by competent authorities in other States must satisfy certain conditions in order toqualify for a 20% risk weight. These conditions are as follows :

the legal status of the entity : the entity cannot be a holding company at the top of a group. This type of entity is risk-weighted at 100%, as are any of its subsidiaries that do not have the legal status of bank or broker-dealer, even whenthey can carry out activities resembling those of investment service providers ;

the activity of the entity : it must correspond to an activity of an investment service provider as defined in Directive93/22/CEE dated May 10, 1993 (the Investment Services Directive) ;


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92/30/CEE, including claims guaranteed directly by them but excluding claims collateralisedby notes or zero-coupon bonds issued by them.

Claims 17 with a residual maturity of one year or less on credit institutions whose headquartersare located outside the OECD Group of countries, and claims guaranteed by such creditinstitutions.

Claims on 17 banking economic interest groups (groupes dintrts conomiques - GIE) oron structures considered by the Secrtariat Gnral de la Commission Bancaire to beequivalent all of whose members are credit institutions, but excluding any GIE the object ofwhich is to structure or grant loans 25.

_ Securities issued by a land bank (socit de crdit foncier) as that term is defined in Law n99-532 of June 25, 1999 on saving and financial security, and which qualify for the privilegedefined in Article 98 of that law (securities referred to as obligations foncires); and securitiesissued by a credit institution having its headquarters in the European Economic Area andwhose legal status is intended to protect the holders of securities equivalent to those referred to

above (such as Pfandbriefe and Cedulas hipotecarias)

Assets in the course of collection 26.


Mortgage loans fully secured by residential real estate which is or will be occupied by theborrower or which is intended for rental, as well as mortgage loans that finance alterations orimprovements to such properties.

Securities representing claims mentioned in the preceding paragraph, with the exception of

portions that are guaranteed, which are assigned the risk weight of the guarantor, and specificshares in Fonds Communs de Crances, which are deducted from capital within the limitsspecified in Regulation n 93-07.

Real estate leasing transactions.

Accrued interest and prepaid expenses where the counterparty cannot be identified.


Claims 17 on central governments and central banks of countries which do not belong to theOECD Group and which are not denominated and financed in the local currency.

Claims 17 on regional and local authorities of countries which do not belong to the OECDGroup.

the entitys administrative authority : this authority, which can be either a bank supervisory agency or a marketregulatory agency, gives an indication of the entitys field of activity.

25 In this case, the risk weight is 100%.

26 The net amount after deduction of corresponding liabilities.


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Claims 17 on credit institutions whose headquarters are located outside the OECD Group ofcountries with a residual maturity of more than one year.

Claims 17 on investment firms whose headquarters are located outside the OECD Group ofcountries.

Claims 17 on customers, including claims on insurance companies, firms not authorised ascredit institutions but affiliated with credit institutions (or parents of credit institutions), andstate-owned enterprises which are not assigned a more favourable risk weight in the precedingparagraphs.

The portion of holdings in capital (participating or subordinated loans and securities) of othercredit institutions that is not deducted from capital.

Fixed assets.

Real estate investments.

All other assets.

3.1.5. ON-BALANCE SHEET NETTING

In accordance with the guiding principles established by the Basel Committee in April 1998,the Sevrtariat G,rale de la Commission Bancaire has decided to authorise the netting of certainbalance sheet elements, subject to the following conditions :

a. Institutions are authorised to net transactions covered by a novation agreement, underwhich all of the institutions obligations to a counterparty in a given currency and on a givendelivery date are integrated in a single net amount which substitutes contractually for theprevious gross obligations. ;

b. Institutions may also net transactions covered by legally valid bilateral nettingagreements ;

c. In both case a) and case b), the bank must demonstrate to its national supervisor that it

possesses :

a netting contract or agreement with the counterparty covering all transactions, and giving theinstitution the right to receive or the obligation to pay only the overall net amount of thepositive or negative market values of all the transactions covered in the event the counterparty

defaults on payments for one of the following reasons : default or cessation of payments,initiation of legal reorganisation or liquidation procedures, or similar circumstances ;

well-founded written legal opinions indicating that, in case of legal challenge, the legal andadministrative authorities involved will rule that the institutions exposure is limited to the netamount under :

the laws in force in the country where the counterparty is established, and, if a foreignbranch of the counterparty is involved, the laws in the country where that branch islocated ;

the law governing the various transactions ;

the law governing the netting contract or agreement ;


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procedures to ensure that the legal framework governing the netting procedures will bereviewed for consistency with any changes in the applicable laws.

Two points should be noted regarding the recognition of master agreements :

First, netting contracts that contain walkaway clauses are not recognised for prudentialpurposes ;

Second, in the absence of a common understanding from the Basel Committee on theapplication of the Accord to multi-branch netting agreements, it will be required :

either that netting agreements be concluded only with countries that recognise the legalvalidity of netting, so that it is possible to report a net amount for all of the transactionscovered by the agreement ;

or, if the agreement covers a larger set of countries, either the institution must providelegal opinions which establish that the failure to execute the agreement in some countries

will not jeopardise the netting of obligations for which prudential recognition of the netbalance is required, or the agreement must contain a severability clause which permitsthe isolation of the transactions carried out in countries where the legal validity of nettingis established (in which case the institutions must possess legal opinions guaranteeing thatthe existence of the severability clause does not jeopardise the validity of the nettingagreement under the relevant laws). If these conditions are satisfied, institutions mayreport net balances with branches located in countries recognising the legal validity ofnetting and gross amounts with branches located in other countries ;

d. the maturity of the liability must be equal to or greater than the maturity of the asset withwhich it is netted ;

e. the positions must be denominated in the same currency ;

f. the institution must have control systems permitting it to manage its risk exposure on a netbasis. In particular, an institution wishing to net on-balance sheet items must be able todemonstrate that it manages its risk exposure on a net basis in a prudent manner and on anongoing basis ;

g. The institution must be able at any time to determine the gross amount its claims on anddebts to each of the counterparties with which it has concluded a netting agreement ;

h. the scope of on-balance sheet netting is limited to bilateral elements (loans and deposits).

3.1.6. ADDITIONAL DETAILS

3.1.6.1. Amount of claims to be taken into account

The amount of claims to be taken into account is the principal plus interest accrued but notyet due, whether the claims take the form of inter-bank loans, loans to customers, or securities (balanceadjusted for any premium or discount).

3.1.6.2. Amount of claims to be included in exposures

The amount of claims to be included in exposures is the balance net of provisions.


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3.1.6.3. Collateral

The collateral must be legally valid and binding on third parties. In particular, the pledging offinancial instruments provided for in the law on modernisation of financial activities of July 2, 1996 isrecognised as collateral, it being understood that the substitution of risk weights is accepted only forclaims collateralised by securities which are perfectly separable and which are accepted in reduction of

the risk-weightings of the commitments which they cover (see preceding paragraphs). Collateral andequivalent guarantees are not recognised unless their maturity is at least equal to that of the assetswhich they cover when the latter have a residual maturity less than or equal to one year. If the residualmaturity of the assets covered is greater than one year, and if the maturity of the collateral or equivalentguarantees is greater than one year but less than that of the assets covered, the beneficiary may transferthe risk to the guarantor : i.e. the risk-weighted exposure on the covered assets is calculated using therisk weight of the collateral or of the guarantor. In order to capture the future exposure that results fromthe disappearance of the collateral before the maturity of the covered items, the beneficiary must recordan additional exposure equal to 50% of the risk-weighted exposure to the covered items.

3.1.6.4. Guarantees

In general, when a claim is guaranteed, the risk weight that applies to the guarantor, if morefavourable, substitutes for that of the counterparty. To qualify for this treatment, the guarantee must bedirect, unconditional, and legally certain. If the guarantee is partial, only the portion of the claim whichis covered by the guarantee receives the reduced risk weight.

When a guarantee takes the form of collateralisation with a zero-coupon security (excludingzero-coupons issued by credit institutions or customers), a fraction of the guaranteed claimcorresponding to the market price of the security, or in the absence of a market price, its capitalisedvalue, is risk-weighted at the rate corresponding to the issuer of the security. Guarantees are notrecognised unless they cover a period at least equal to the maturity of the assets which they cover whenthe latter have a residual maturity less than or equal to one year. If the residual maturity of the assetscovered is greater than one year, and if the term of the guarantee is greater than one year but less thanthat of the assets covered, the beneficiary may transfer the risk to the guarantor : i.e. the risk-weightedexposure on the covered assets is calculated using the risk weight of the guarantor. In order to capturethe future exposure that results from the disappearance of the guarantee before the maturity of thecovered items, the beneficiary must record an additional exposure equal to 50% of the risk-weightedexposure to the covered items.

Claims which are guaranteed and for which the repayment risk on principal and interest are notthe same 27 must be broken into a set of flows each of which presents a homogenous credit risk. Eachset of homogenous flows is then valued at its financial contribution to the total amount of the claim i.e. in proportion to its share of the net present value of the claim and then risk-weighted according tothe risk attached to it. The Secrtariat Gnral de la Commission Bancaire will set the conditions for

application of these provisions as the need arises.

3.1.6.5. Securitisations

The treatment of securitisation transactions is specified in Annex 18, which reproduces theprovisions published in Bulletin n 27 of the Commission Bancaire 28.

27 This is the case for transactions in which interest or coupons, but not principal, are indexed to a reference portfolio, or forsecurities for which only the payment of principal on the contractually agreed date is guaranteed (claims of a compositenature).

28 Bulletin n 27 of the Commission Bancaire, November 2002 New prudential provisions relating to securitisationtransactions.


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Recourse clauses that engage the selling institution to take back claims before or after theyreach their maturity (aside from cases of liquidation of a fund or a vehicle), whatever their nature recourse obligations or rights, rights of pre-emption are considered a form of credit enhancement.They oblige the selling institution to apply the prudential treatment defined in Annex 18, and also :

- to record in its off-balance sheet positions any recourse commitments, including implicitrecourse commitments (recourse rights or rights of pre-emption) ;

- to publish, in an annex to its annual financial accounts, detailed information on thesecuritisation transaction, in accordance with the provisions of Regulation n 93-06 of theComit de la Rglementation Bancaire et Financire ;

- to pass provisions, as needed and in accordance with Article 3 of Regulation n 93-06, in theamount of the risk of default on the claims sold as valued at the end of each accountingperiod.

In the light of Article 10052 of the Annex to Regulation n 99-07 of the Comit de la Rglementation Comptable, which introduced new provisions relating to the consolidation of special

purpose entities29

, the selling institution must obtain the determination of its external auditors as towhether or not a securitisation transaction that is envisaged or has been undertaken should bedeconsolidated. The Secrtariat Gnral de la Commission Bancaire may for prudential reasonsimpose a more precautionary treatment for calculating the capital ratio.

Finally, a 0% credit conversion factor applies to liquidity facilities extended in the frameworkof securitisation transactions when the following conditions are satisfied :

- the liquidity facility is protected from credit risk by a credit enhancement mechanism,

and

- the contractual maturity of the liquidity facility is less than or equal to one year, or the

institution providing the liquidity facility can cancel it unconditionally, at any time andwithout notice.

On the one hand, liquidity facilities which can be drawn in order to cover a credit risk, notablyin the case of default of the selling institution, cannot receive a 0% credit conversion factor. In thatveine, it should be noted that the commingling risk, defined as the risk, notably in the case ofdefault of the selling institution, that cash flow payments could be freezed, must be viewed as a creditrisk. Consequently, a 0% credit conversion factor cannot apply to liquidity facilities which are notprotected from such a risk by a specific mechanism. On the other hand, the contractual maturity of aliquidity facility covered by a commitment for renewal for a fixed period is calculated from the date onwhich the commitment is signed.

Liquidity facilities which provide credit enhancement must be treated in accordance with theprovisions of Annex 18.

Liquidity facilities which do not provide credit enhancement and which do not satisfy theconditions cited above receive a credit conversion factor of 50%.

3.1.6.6. Securities held as assets

Securities held as assets are risk weighted according to their issuer. The risk weight isapplied to the balance net of deliverables if the securities are the object of a forward sale on themonthly settlement market (this netting must be carried out security by security). Such netting does not

29 Including Fonds Communs de Crances formed under the regime of the Law of December 23,1988, as amended.


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extend to options covering spot positions in securities (in particular; securities covered by the sale ofcall options).

3.1.6.7. Shares in UCITs and ordinary shares in FCCs

Shares in UCITs and ordinary shares in Fonds Communs de Crances (FCCs) may be

assigned the risk weights corresponding to the nature of each asset held by such organisations,provided that the credit institution is able to establish the composition of the assets. However, thepledging of such shares as collateral does not reduce the risk weight of the assets covered by thecollateral.

3.1.6.8. Repurchase agreements :

securities received in repurchase agreements in the framework of a master agreementestablished under the auspices of the Banque de France are treated as guarantees. They valuedat their market value and risk-weighted at the lower of the risk weight of the counterparty andthe risk weight of the issuer of the securities. When the securities are not delivered, the riskweight of the counterparty applies ;

securities delivered in a repurchase agreement continue to be treated as exposures of the seller(and the applicable risk weight remains that of the issuer of the securities) ;

margin calls paid in the framework of the master agreement can take the form of supplementaryremittance of cash, bills or securities. When these supplementary remittances are made in cash,they are recorded as miscellaneous receivables and risk weighted according to the nature of thecounterparty. When the remittances are made in the form of bills or securities, they arerecorded off-balance sheet as other values transferred in guarantee and are not counted as suchin the calculation of risk-weighted exposures. However, the corresponding bills or securitiescontinue to be risk-weighted according to the nature of the issuer of the securities.

3.1.6.9. Securities lending and borrowing :

Unsecured (sec) lending and borrowing of securities and irregular deposits of securities 30:

for the lender, securities lent are risk-weighted by the higher of the rate that applies to theborrower and the rate for the issuer of the securities ;

securities borrowed are not counted as exposures of the borrower.

Lending and borrowing of securities secured by cash : these transactions are treated in allrespects like repurchase agreements (see above).

Lending and borrowing of securities secured by securities :

for the lending institution, the securities 31 are risk weighted at the higher of :

the risk weight of the issuer of the securities lent,

30 Securities on deposit may be used by the borrowing institution, as long as the lender has not failed ; for example they may besold or used to guarantee refinancing operations.

31 Whether the securities lent are held on the lenders its own account or have previously been borrowed.


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the lower of the risk weight of the borrower and the risk weight of the issuer of thesecurities received in collateral,

for the borrowing institution, the securities borrowed are not counted as exposures. Thesecurities given in guarantee in the transaction continue to be risk-weighted according tothe nature of the issuer of the securities, whether or not they are delivered, in accordancewith the general provisions governing values given in guarantee.

The Secrtariat Gnral de la Commission Bancaire will set the conditions forapplication of these provisions as the need arises.

3.1.6.10. Temporary sales of securities (repurchase agreements, securitieslending and borrowing and securities received in repurchaseagreements) :

In place of the provisions set forth in Points 3.1.6.8 and 3.1.6.9, institutions may applythe regime set forth in Regulation n 95-02, subject to the modifications given below :

- For each temporary sale of assets, Regulation n 95-02 defines the risk basis as the valueof the items sold minus the value of the items received, multiplied by the risk weight thatapplies to the counterparty involved.

- Accrued interest is included in the calculation of the market value of the amounts lent orborrowed and of the guarantee. Netting of these transactions is recognised subject to theconditions set forth in Point 3.1.5.

- Institutions must adhere to the following rules :

No credit is given for securities received if either of the following conditions applies :

the issuer of the securities is related to the counterparty, in the meaning of Article 3of Regulation n 93-05 ;

the securities are not delivered or the transaction does not receive an equivalentguarantee.

In order to take account of the volatility of the net exposure to the counterparty, a flat-rate deduction of 5% is applied to the market value of the assets received, whatever theirform (cash, government securities, or securities issued by other entities). This discount isapplied to the position net of repurchase and reverse repurchase agreements for the samesecurity.

When an institution uses this method, it must also apply it to unsecured securities lending andto irregular deposits of securities.

- By reference to the provisions of Article 3 of Regulation n 89-07 and to Article 1 ofInstruction n 94-06, securities transferred with a guarantee against the risk of failure ofthe issuer 32 must be recorded as shares received in repurchase agreements and treatedas temporary sales of securities.

32 The guarantee can take the form of a credit derivative instrument or an equity swap.


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3.1.6.11. Sales with repurchase option :

for the transferee, securities received in a sale with repurchase option referred to in Article 4-IIof Regulation n 89-07 are considered guarantees by the transferor. They are risk-weighted atthe lower of the risk weight of the transferor and the risk weight of the issuer of the securities ;

for the transferor, the securities sold are recorded as off-balance sheet instruments with a creditconversion factor of 100% (see below).

3.1.6.12. Guarantee deposits and contributions to Clearnets clearing fund

Guarantee deposits placed with clearing houses are risk-weighted at 20% if the clearing bodyis a credit institution, 0% if the commitments of the body are guaranteed by an entity which is itselfrisk-weighted at 0%, and 100% in all other cases.

Contributions paid into the clearing fund of Clearnet are risk-weighted at 20%.

3.1.6.13. Option premiums

For option premiums purchased by the institution, two cases are distinguished :

for transactions which are not carried out on an organised exchange with daily marginadjustment, the underlying is included in the calculations for off-balance sheet financialinstruments, and the premiums therefore are not counted as exposures ;

for instruments which are traded on an organised exchange, and whose underlying are notcounted as off-balance sheet forward financial instruments, the purchased premiums arecounted as exposures in the amount of the asset and risk-weighted according to the type ofclearing house (see above)

3.1.6.14. Special casesThe following risk weight applies to carry-back tax claims of businesses on the Public

Treasury which are sold to a credit institution in a Dailly transaction :

- 20% for commitments covered by a Dailly sale of the receivable from the Public Treasury,provided the Public Treasury has acknowledged receipt of the notification of the sale, andboth the existence of the claim and the absence of potential adverse claims on the situation ofthe seller have been verified. The 20% risk weight is composed of a credit-risk equivalent of20%, risk-weighted at 100%, on the seller ; plus a credit-risk equivalent of 80%, risk-weighted at 0%, on the State,

- 0% for irrevocable off-balance sheet commitments of less than one year to purchase carry-back tax claims. If the credit is approved in advance, i.e. before the conditions mentionedabove have been completely satisfied, a risk weight of 100% applies until the conditions havebeen fulfilled.

3.2. Off-balance sheet exposures

Off-balance sheet exposures are converted into credit-risk equivalents ; the resulting amountsare then risk-weighted in the same way as on-balance sheet transactions, according to the type ofcounterparty or, in the case of certain transactions in securities, the type of issuer.

The credit conversion factors applied to the nominal amounts of commitments are intended toreflect both the probability that a commitment will result in an on-balance sheet exposure and theestimated magnitude of the risk.


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Two fixed credit conversion factor values have been assigned to commitments that take theform of a line of credit or a revolving credit : 0% for commitments with an original maturity of lessthan one year or for commitments of any maturity which can be unconditionally cancelled at any time(or cancelled upon the expiration of a notice period that conforms strictly to legislation or bankingpractice relating to consumer protection) ; and 50% for all other commitments 33.

The initial maturity which determines the choice of credit conversion factor should beevaluated in terms of the economic substance of the commitment and may therefore differ from thecontractual maturity. In practice, this means that the factor of 50% should be applied in cases wherethe bank is committed to the beneficiary for a period of more than one year following the date that thefacility is granted.

A maximum risk weight of 50% applies to commitments which take the form of derivativeinstruments and which are made to counterparties who would normally be risk-weighted at 100%.

3.2.1. OFF-BALANCE SHEET EXPOSURES, EXCLUDING DERIVATIVE

INSTRUMENTS

3.2.1.1. INSTRUMENTS FOR WHICH THE CREDIT CONVERSION FACTOR IS

100%

Financial guarantees (financial standby letter of credit). In particular, this category includesguarantees of payment or repayment.

_ Counter-guarantees provided to credit institutions covering exposures to other creditinstitutions.

Guarantees of repayment to credit institutions by other credit institutions.

Acceptances and commitments to pay.

Uncancellable lines of credit which are certain to be drawn, and surety bonds serving as creditsubstitutes.

Substitution for a counterparty decredere (ducroires).

Securities due to the institution 34 35.

Temporary asset sales 27 in which the bank retains the credit risk (i.e. there is a strong

probability that the selling bank will repurchase the asset36

).

33 All Note Issuance Facilities" and "Revolving Underwriting Facilities" are assigned a credit conversion factor of 50%.

34 These instruments must be risk-weighted according to the type of asset and not the nature of the counterparty i thetransaction.

35 This includes in particular commitment, net of Cette rubrique comprend notamment les engagements, nets desrtrocessions, relatifs des interventions l'mission, garanties de prise ferme ou autres garanties de placement, ainsi queles achats sur les marchs terme de valeurs mobilires jusqu' la date de rglement des titres.

36 In particular, sales with repurchase rights referred to in Article 4-II of Regulation 89-07 (sales with repurchase option).


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Forward asset purchases and 27.28, and unpaid purchases of shares and other securities.

3.2.1.2. INSTRUMENTS FOR WHICH THE CREDIT CONVERSION FACTOR IS 50%

First demand guarantees of a technical nature (performance standby letter of credit)

including performance guarantees and guarantees of contract execution or completion,repayment of deposit, bids, or contract holdbacks.

Refinancing agreements and confirmed lines of credit with an initial maturity greater than oneyear.

Surety bonds, endorsements and other guarantees (other than first-demand guarantees andrepayment guarantees), i.e. instruments that do not constitute direct credit substitutes),including in particular guarantees of repayment of deposits or financing of subcontractors.

Note Issuance Facilities and Revolving Underwriting Facilities.

Project finance commitments.

Lines of credit that can be drawn in several segments, if any of the segments is longer than oneyear; however, the segments may be considered separately if there is no possibility of transferbetween them and if they serve distinct and independent purposes..

Commitments of more than one year in an amount that varies seasonally (the credit conversionfactor applies to the maximum amount of the commitment).

Commitments of indefinite maturity, or renewable commitments that the bank can cancelunconditionally at any time after a notice period (evergreen commitments).

Documentary lines of credit issued or confirmed by a credit institution, where the underlyinggoods do not serve as collateral.

Backup lines for commercial paper.

Guarantees provided by the presenting institution for the payment of cash compensationpayable by the initiator in a purchase of securities as part of a takeover bid (offre publiquedachat) or exchange offer (offre publique dchange).


Guarantees (other than on first demand) covering good execution of contracts, bids or contractholdbacks, taking the form of surety bonds.

Issued or confirmed documentary credits where the underlying merchandise serves ascollateral.

Guarantees of administrative or tax obligations.

EC Surety bonds (cautions communautaires).

Commitments provided to UCITs to guarantee their capital or yield 37.


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Surety bonds prescribed by laws governing financial guarantees required to practice certainprofessions, including in particular surety bonds covering the restoration of mine sites.

Guarantees covering financing of a takeover bid (offre publique dachat).


Refinancing agreements and confirmed lines of credit with an initial maturity of one year orless.

Commitments which can be cancelled unconditionally at any time and without notice 38.

Commitments which can be renegotiated at the end of a period of at most one year, if therenegotiation procedure involves a complete new review of the financial structure of thebeneficiary and if the bank has complete discretion not to renew the commitment.

Simple OPE tenders, provided that the commitment is included in the banks off-balance

accounts and the bank can confirm the magnitude of its commitment

Multi-optional financing facilities (MOFF) and other forms of composite financing must besplit into their constituent components (lines of credit, NIF,...) and each component assigned acorresponding credit conversion factor. If the total value of the components exceeds the value of thefacility, the components with the smallest credit conversion factors are ignored until the excess iseliminated.

In the case of commitments to commit where the credit conversion factor of the secondcommitment depends on the maturity (for example, a commitment to extend a future credit line), theinitial maturity is measured from the date that the first commitment is granted. If the first commitmentis cancellable at any time, the credit conversion factor is 0%.

In the case of commitments to commit where the credit conversion factor of the secondcommitment does not depend on the maturity (for example, a commitment to extend a future suretybond), the credit conversion factor is 0% if the maturity of the first commitment is less than or equal toone year or if the first commitment is cancellable at any time. Otherwise it is equal to the creditconversion factor of the second commitment.

Lines of credit where the credit is for more than one year and the line must be drawn withinone year at most are considered to have a maturity of one year at most, provided that at the end of thattime the undrawn portion of the credit line is automatically cancelled.

37 In accordance with Note n 92-09 of the Secrtariat Gnral de la Commission Bancaire, these commitments are treatedfor accounting purposes as commitments to customers, in the amount specified in the contract, or the contract does notspecifiy an amount, for the nominal value of the shares which are covered by the guarantee. In calculating the capital ratio,a credit conversion factor of 20% is applied. Institutions may apply the principle of transparance to these transactions, i.e.they may apply the risk weights associated with the assets held by the UCIT.

38 This does not include lending that falls within the scope of application of Article L. 313-12 of the Code Montaire etFinancier.


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3.2.2. OFF-BALANCE SHEET EXPOSURES IN THE FORM OF DERIVATIVEINSTRUMENTS.

3.2.2.1. MEASUREMENT OF GROSS EXPOSURE

The credit-risk equivalent of derivative instruments is calculated using the method of mark tomarket.

The calculation covers only over-the-counter derivative transactions; commitments involvingexchange-traded derivatives are excluded. 39.

Five broad categories of instruments are defined : interest rate, currency and gold, equity,precious metals (excluding gold), and commodities. Contracts which do not fall clearly into one ofthese categories are treated as commodities instruments.

3.2.2.1.1. TYPES OF TRANSACTIONS

Interest-rate instruments means :

interest-rate swaps in the same currency ;

forward rate agreements (FRA) ;

interest-rate forwards ;

interest rate options (purchased contracts only) ;

other contracts of the same nature (caps, floors, collars,...).

Currency and gold instruments means :

interest-rate and foreign-currency swaps ;

foreign exchange forwards ;

currency forwards ;

currency options (purchased contracts only) ;

other contracts of the same nature 40.

Currency contracts with an initial maturity of 14 calendar days or less are exempted. Thisexemption does not apply, however, to gold contracts, which are subject to credit risk capitalrequirements whatever their initial maturity.

Equity instruments means all forward and swap contracts, purchased options and similarderivative instruments based on shares or share indexes.

39 However, transactions carried out on markets treated as organised exchanges in accounting valuation (within the meaningof Regulation n 88-02 of the CRB) are included.

40 Foreign exchange warrants are treated as foreign exchange options. Only purchased warrants are included, unless thetransaction involves a bank repurchasing a warrant issued by the same bank.


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Precious metal instruments means all forward and swap contracts, purchased options andsimilar derivative instruments based on metals other than gold, such as silver, platinum, palladium...

Finally, commodities instruments means all forward and swap contracts, purchased optionsand similar derivative instruments whose underlying are contracts for energy products, agriculturalproducts, non-ferrous metals (such as aluminium, copper and zinc), or other non-precious metals.

Credit derivative instruments, which are designed to buy or sell the credit risk of a referenceasset, is accorded a conservative treatment. The institution selling protection records a credit risk onthe reference asset; the exposure is treated as a direct credit substitute attracting a credit conversionfactor of 100%, and risk-weighted according to the nature of the issuer of the reference asset. Thebuyer of protection also records a risk on the reference asset, but it is permitted to substitute the riskweight of the protection seller for the risk weight of the issuer. This treatment is subject to prudentialconditions set forth in Annex 15. (The treatment of credit-linked notes is slightly different : see Annex15.)

3.2.2.1.2. METHOD FOR MEASURING THE CREDIT-RISK EQUIVALENT

(CURRENT EXPOSURE AND POTENTIAL FUTURE EXPOSURE)

The credit-risk equivalent of derivative instruments is determined by taking the sum of :

the total replacement cost (valued at the market price 41) of all contracts that are in-the-money,

an add-on for the potential future exposure, calculated on the basis of the nominal amountrecorded on the institutions books 42 and multiplied by the following add-ons factors 43 44

which depend on the residual maturity and the type of contract.

Residual maturity 45 Interest-ratecontracts Currency andgold contracts Equitycontracts

Precious metalcontracts

(excluding gold)

Commoditiescontracts

Up to one year................. 0,0% 1,0% 6,0% 7,0% 10%

More than one year andless than or equal to fiveyears

0,5% 5,0% 8,0% 7,0% 12,0%

More than five years ....... 1,5% 7,5% 10,0% 8,0% 15,0%

41 For interest-rate and currency swaps, the market price is calculating using one of the methods referred to in Regulationn 90-15 as amended by Regulation n 92-04 (before adjusting the market value for counterparty risk.).

42 The add-on is calculated on the notional amount of all contracts, whatever their market value, i.e. whether they are in orout of the money.

43 Except for variable rate swaps in the same currency, for which credit risk is calculated exclusively on the basis ofreplacement cost without an add-on for potential future risk.

44 For contracts involving multiple exchanges of principal, the add-on factors are multiplied by the number of paymentsremaining to be made.

45

For contracts whose value is automatically reset to zero after a payment, the residual maturity is the interval between twosuch resettings to zero (with a minimum add-on of 0,5% for interest-rate contracts which have a residual maturity of morethan one year).


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For contracts that are not covered by a novation agreement or a netting agreement satisfying theconditions set forth in Point 3.2.2.2.1, the replacement cost is equal to the market value of the contract,if greater than zero. If the market value is less than zero, the replacement value is zero. However, thereplacement cost of any exchange rate contracts whose initial maturity does not exceed 14 calendardays is zero.

For contracts that are covered by the same novation agreement or netting agreement, whichsatisfies the conditions set forth in Point 3.2.2.2.1, the replacement cost is equal to the net of themarket value of the individual contracts, if greater than zero. If the net of the market values is less thanzero, the replacement value is zero. Purchased options and exchange rate contracts whose initialmaturity does not exceed 14 calendar days are included in the netting calculation.

3.2.2.2. NETTING

Under the terms of an Amendment to the 1988 Accord adopted by the Basel Committee inDecember 1994, netting of positions with the same counterparty, which previously was allowed only inthe framework of a novation agreement, is extended to cover contracts negotiated within a masteragreement that satisfies the conditions set forth in Article 33 of Law n85-98 of January 25, 1985 asamended and Chapter III of Banking Law n96-597 of July 2, 1996.

Another amendment to the 1988 Accord, adopted by the Basel Committee in April 1995,permits the recognition of netting in the definition of add-on factors.

3.2.2.2.1. CONDITIONS FOR RECOGNITION OF NETTING

a. Institutions are authorised to net transactions subject to novation, under which all of theinstitutions obligations to a counterparty in a given currency and on a given delivery date areintegrated in a single net amount which substitutes contractually for the previous gross

obligations. ;

b. Institutions may also net transactions covered by legally valid bilateral netting agreements ;

c. In both case a) and case b), the bank must demonstrate to its national supervisor that itpossesses :

a netting contract or agreement with the counterparty covering all transactions, and giving theinstitution the right to receive or the obligation to pay only the overall net amount of thepositive or negative market values of all the transactions covered in the event the counterpartydefaults on payments for one of the following reasons : default or cessation of payments,initiation of legal reorganisation or liquidation procedures, or similar circumstances ;

well-founded written legal opinions indicating that, in case of legal challenge, the legal andadministrative authorities involved will rule that the institutions exposure is limited to the netamount under :

the laws in force in the country where the counterparty is established, and, if a foreignbranch of the counterparty is involved, the legislation in the country where the branch islocated ;

the law governing the various transactions ;

the law governing the netting contract or agreement ;


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procedures to ensure that the legal framework governing the netting procedures will bereviewed for consistency with any changes in the governing laws.

Two points should be noted regarding the recognition of master agreements :

First, netting contracts that contain walkaway clauses are not recognised ;

Second, in the absence of a common understanding from the Basel Committee on theapplication of the Accord to multi-branch netting agreements, it will be required :

either that netting agreements be concluded only with countries that recognise the legalvalidity of netting, so that it is possible to report a net amount for all of the transactionscovered by the agreement ;

or, if the agreement covers a larger set of countries, either the institutions must providelegal opinions which establish that the failure to execute the agreement in some countrieswill not jeopardise the netting of obligations for which prudential recognition of the net

balance is required, or the agreement must contain a severability claus

cooke methodology

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