Capital Risk Management

Overview

Capital risk management is integral to ADCB’s approach to financial stability and sustainability management. It helps us to maintain a strong capital base to support the development of our business, to meet regulatory capital requirements at all times and to maintain strong credit ratings.

Our capital-management strategy is driven by the strategic aims of the Bank and the risk appetite set by the Board. The Bank’s objectives when managing capital, which is a broader concept than the ‘equity’ on the face of our statement of financial position, are:

• to comply with the capital requirements set by the Central Bank of the UAE;
• to safeguard the Bank’s ability to continue as a going concern and increase the returns for the shareholders; and
•  to maintain a strong capital base to support the development of our business.

Our Approach to Capital Risk Management

We employ a forward-looking, risk-based approach to capital risk management. Capital demand and supply are actively managed at a business level, taking into account the regulatory, economic and commercial environment in which ADCB operates. ADCB employs techniques based on the guidelines developed by the Basel Committee and the Central Bank of the UAE. For credit and market risk, the Central Bank has issued guidelines for implementation of the standardised approach, and banks have been required to comply and report under Pillar 2 Internal Capital Adequacy Assessment Process (ICAAP) requirements since March 2010. For operational risk, the Central Bank has given banks the option of using the basic indicators approach or the standardised approach. We have chosen to use the standardised approach.

The Bank’s approach for calculating its capital requirements under Basel II (Pillar 1) is as follows:

Credit risk: We use the standardised approach to calculate our capital requirements for credit risk. This approach allows the use of external ratings from designated credit rating agencies, wherever available, in determining the appropriate risk weights. The risk weight is determined by the asset class and the external rating of the counterparty. The net exposure incorporates off-balance-sheet exposures after applying the credit conversion factors and credit risk mitigants.

Market risk: We use the standardised approach for the regulatory market risk capital requirement.

Operational risk: We use the standardised approach for computing capital requirement for operational risk.

We also prepare an annual comprehensive ICAAP document. This document is a detailed assessment by the Bank of our risk profile, approaches to assess and measure various material risks, and capital planning under regular and stress scenarios.

The Bank also publishes annually a more detailed report of all material sector concentrations and risks as part of the Pillar 3 framework of Basel II.

Capital Planning and Budgeting Process

Regulators, in view of the systemic risk that a bank failure carries, the losses it can cause to depositors and the consequent cost of bailouts by the government, rigorously regulate the capital structure of banks. The Basel II Accord focuses on risk management and links the business profile of a bank to its risk profile and, subsequently, to regulatory capital. There is thus an automatic calibration of business profile to the regulatory capital. Thus, the capital structure of ADCB is the fulcrum around which our strategic decisions revolve. A diagrammatic view of the process is presented below:

In practical terms, the role of capital in the Bank is to provide creditor protection. In other words, the role of capital is to act as a buffer against future unidentified losses, thereby protecting depositors and other creditors. Collective provisions provide a cushion against loss events for which there is objective evidence but whose effects are not yet evident, and the capital provides a cushion against unexpected losses. The amount of capital the Bank would hold, therefore, depends on the loss distribution (whether arising from credit, market, operational or any other kinds of risk), our risk appetite, as well as our risk-bearing capacity. Such determination of capital would cover all the Bank’s material risks and the methodology to carry out such calculation.

The Bank would also ensure that quality of capital as a loss-absorbing capacity, without any bearing on the solvency of the Bank (which would cover equity capital and other shareholder funds), would be maintained at all times at such level as is approved by the Board of Directors.

A diagrammatic view of our business strategy drivers is presented below:

Capital Allocation

The allocation of capital between specific operations and activities is, to a large extent, driven by optimisation of the return achieved. The amount of capital allocated to each operation or activity is based primarily upon the regulatory capital, but in some cases the regulatory requirements do not reflect fully the varying degree of risk associated with different activities. In such cases, the capital requirements may be flexed to reflect differing risk profiles, subject to the overall level of capital needed to support a particular operation or activity from falling below the minimum required for regulatory purposes. The process of allocating capital to specific operations and activities is undertaken independently of those responsible for the operation by Bank Risk & Credit and Finance functions and is subject to review by the ALCO as appropriate.

Capital Position at 31 December 2014

The Bank’s capital position applying prevailing rules as at 31 December 2014 is set out in Note 50 of the audited financial statements.