Capital Adequacy Framework for Islamic Banks (CAFIB)
Capital Adequacy Framework for Islamic Banks 27 May 2015 | Nurhayati Mohd Khalid & Mohammad Hafiz Norazmar | Islamic Banking and Takaful Department
1
Outline • Background Development of Capital Adequacy Framework for Islamic Banks (CAFIB) • CAFIB requirements RWA calculation Capital component • Investment Account as risk absorbent
2
Capital Adequacy Framework for Islamic Banks (CAFIB) Implemented since 2008 Objectives: – to cater for specific structures of Islamic financial transactions; and – to standardise the approach in identifying and measuring risks for the computation of capital adequacy requirement Islamic banking institutions subject to the capital adequacy framework based on IFSB Capital Adequacy Standard (CAS) – Complement Pillar I of Basel II – Risk profiles & exposures determined based on underlying Shariah contracts (asset-based, lease-based & equity based): – Adopt risk measurements, covering credit risk, market risk & operational risk Minimum capital adequacy requirements of 8%, consistent with Basel requirement
Risk profile Shariah contracts contracts Shariah Trading book book instruments, instruments, Trading Forex, Commodities Commodities && Forex, Physical assets Physical assets
Risk exposures exposures & & Risk measurement measurement Credit risk; Market risk; and
Operational risk
Capital requirement Minimum of 8%
3
CAFIB: Further enhancements made in 2013 to cater for Basel III capital reform Revision made effective 1 Jan 2013 Objectives: – to raise the quality & consistency of the total capital – to cater for specific structures of Islamic capital instruments Enhancements – Capital base to be predominantly common equity Tier 1 (CET1 i.e. ordinary shares, retained earnings and reserves) – Other non-common equity capital instruments to be of higher quality – Deductions and prudential filters made via CET1 More granular minimum capital adequacy requirements
Capital Risk profile ratios 4.5% CET1 Shariah contracts 8% TC Trading book instruments, Forex, 10.5% TC&+Physical CCB In Commodities assets 2018 13% TC + CCyB
Risk exposures & Capital instruments measurement CET1 Additional Tier 1 Tier 2
Enhancing Risk Coverage (for Counterparty Credit Risk) - Stressed input - Credit Valuation Adjustment (CVA) - Central Counterparties (CCP)
Yet to be implemented
4
Basel III implementation timeframe for Malaysia
5
Key features addressing Islamic financial transactions
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Separate compliance for Islamic banking windows
RWA Calculations
• Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Risk Management
Scope: Islamic banking institutions & Islamic banking windows are subject to CAFIB Holding Company
Holding Company
Parent Bank (Conventional)
Islamic Bank (Domestic)
Islamic Bank (Foreign)
Islamic Banking Subsidiary
Conventional Bank
Islamic window
“Bank within a bank”
Subject to CAFIB
•
•
Separate minimum capital adequacy ratios at Islamic window level, in addition to compliance on consolidated basis at conventional bank level - i.e. Islamic window’s total capital (Islamic banking fund) must be at minimum 8 % of its total RWA Islamic window may raise its own capital e.g. via issuance of common equities or sukuk that qualify as CET1, AT1 or T2 - Conversion or write off of AT1 or T2 must be allocated to the Islamic banking fund
Key features addressing Islamic financial transactions
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Separate compliance for Islamic banking windows
RWA calculations
• Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Various Shariah contracts to support Islamic financial transactions Shariah Contracts
Fee Based
Equity Based
Sale Based • Murabahah (cost plus mark up) • Salam (forward sale) • Istisna` (construction/ manufacturing) • Ijarah (lease)
• Mudarabah (profit sharing & loss bearing) • Musharakah (profit & loss sharing)
• • • •
Wakalah (agency) Wadiah (safe keeping) Kafalah (guarantee) Rahnu (collateral)
Supporting Arrangements • Urbun (earnest money) • Hamish Jiddiyyah (security deposit) • Wa`d (undertaking) • Hibah (gift)
The Shariah contracts are applied to structure various Islamic banking products
Asset
Liability
Asset-based financing • Murabahah • Ijarah • Istisna
Investment Account • Mudarabah • Musharakah • Wakalah
Profit Sharing financing • Mudarabah • Musharakah • Wakalah
Islamic deposit • Wadiah • Qard • Tawarruq
The unique features of each Shariah contract entail different risk profile / exposure to Islamic banks… 9
Risk exposures are determined based on stages of Shariah contract Market Risk – based on type of risk eg. inventory risk, fx risk 1
Asset-based Sale and purchase contracts • Murabahah
Stages of contract Purchase of assets for sale or leasing
(mark-up sale)
• Salam (forward purchase)
• Istisna’ (Purchase of asset under construction)
Sell to customer on deferred payment terms
Leasing contracts
Or
• Ijarah • Ijarah Muntahia Bitamleek
Lease to customer
Risk exposure/ profile Market risk • Price risk arising from holding of assets Transform Credit risk • Sales or rental receivables due from counterparty
Credit Risk - Based on asset class eg. Sovereigns & Central Banks, Banking Institutions, Corporates, Regulatory Retail*, Residential Real Estate* * Applicable to Murabahah or Ijarah contracts. For recognition of other contracts, only allowed if credit risk profile is similar to Murabahah or Ijarah
Risk exposures are determined based on stages of Shariah contract Treated as equity exposure: ▪ 100% (publicly traded) ▪ 150% (non-publicly traded) Supervisory Slotting Criteria** ▪ RW ranging 70% to 400%
2
Profit sharing Joint venture/ partnership contract • Mudharabah (Profit sharing)
• Musharakah (Profit and loss sharing)
Stages of contract • Capital investment in commercial entities • Profits are shared based on agreed ratio • Losses are shared or borne by capital providers
Risk exposure/ profile Equity risk • Equity position in banking book - Capital impairment
Market risk • Equity position trading book - underlying assets
Treated as equity exposure: Specific & general risk charge depending on type of equity.
Murabahah
1 Asset held for sale
Stages of contract
Purchase Asset
2 Asset sold & payment due from obligor Sell Asset
Capital Treatment
Murabahah & Non-binding MPO1
Binding MPO
Credit Risk: None Market risk: 15% capital charge (x) exposure amount Credit Risk2: RW based on obligor’s ratings (x) exposure amount net MV of asset Market risk: None
1Murabahah 2 Assuming
Credit risk: RW based on obligor’s ratings (x) exposure amount Market risk: None Credit risk: RW based on obligor’s ratings (x) exposure amount
Market risk: None
for Purchase Orderer with non-binding Agreement to Purchase (AP) islamic bank has legal recourse to obligor for any shortfall after asset disposal
12
Operating Ijarah
Stages of contract
1 Purchase Asset
2
Asset held for lease
Lease Asset
3
Asset leased & rental due from lessee
End of lease period
Residual life of asset
Capital Treatment
NonBinding Agreement to Lease (AL)
Binding AL
Credit Risk: None Market risk: 15% capital charge (x) exposure amount
Credit Risk1: RW based on lessee’s ratings (x) exposure amount net MV of asset
Credit risk: RW based on lessee’s ratings (x) exposure amount net asset recovery value
Credit risk: None Market risk: 15% capital charge (x) exposure amount
Market risk: 8% capital charge on asset residual value
Similar as above
Market risk: None
1 Assuming
islamic bank has legal recourse to lessee for any shortfall after asset disposal
13
Ijarah Muntahia Bitamleek (IMB)
Stages of contract
1 Purchase Asset
2
Asset held for lease
Lease Asset
Asset leased & rental due from lessee
End of lease period & transfer of asset to lessee
Capital Treatment
NonBinding Agreement to Lease (AL)
Binding AL
Credit Risk: None Market risk: 15% capital charge (x) exposure amount
Credit Risk1: RW based on obligor’s ratings (x) exposure amount net MV of asset
Credit risk: RW based on obligor’s ratings (x) exposure amount net asset recovery value Market risk: None
Similar as above
Market risk: None
1 Assuming islamic bank
has legal recourse to lessee for any shortfall after asset disposal
14
Approach for market & operational risk Market Risk
Operational Risk
• Definition: - Market risk is defined as risk of losses in onand off-balance sheet positions arising from movements in market prices
• Definition: - Risk of losses resulting from inadequate or failed internal processes, people and systems or from external events - excludes strategic & reputational risks - includes Shariah compliance risk
• Types of market risk: – Benchmarking rate risk and equity risk : Capital charges are calculated based on Specific risk and General risk – Foreign exchange risk: Capital charge is calculated based on exposure to single currency and Portfolio mix – Commodity risk: 15% capital charge is applied based on either maturity ladder or simplified approach – Inventory risk: 15% capital charge is applied to assets held as inventory with a view to resale or lease More prevalent in Islamic financial transactions e.g. murabahah to purchase orderer or operating ijarah
More prevalent in Islamic financial transactions.
• Approaches: Basic Indicator Approach
Standardised/ Alternative Standardised Approach
Increased sophistication
Advanced Measurement
Key features addressing Islamic financial transaction requirements
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
Separate compliance for Islamic banking windows
RWA calculations
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Main changes for capital instruments
Basel I/II • Common Equity • Hybrid Tier 1 (Non-Inno Tier 1 & Inno Tier 1) • Tier 2 Subordinated instruments
Basel III • CET1 • Additional Tier 1 • Tier 2 Subordinated instruments
• Loss absorption limited to repayments terms & level of subordination • Step-ups allowed
• Principal loss absorption • Non-Viability Loss absorption • Step-ups not allowed
No specific treatment for Shariah compliant instruments
Treatment for Shariah compliant instruments clarified
Specific requirements on Shariah-compliant capital instruments
Shariah contracts
• Additional Tier 1 use only non-exchange based contracts (ie. Musyarakah & Mudarabah) • Due to perpetuality of instruments • No restrictions on type of Shariah contract for Tier 2 instruments
Loss absorption mechanism
• Conversion or write-off mechanism are allowed for exchange-based contracts (eg. conversion of sub-debt into ordinary shares) • Conversion mechanism for non-exchange-based contracts (eg. conversion of Additional Tier 1 into ordinary shares)
Use of SPV
• Use of an independent SPV is allowed in structures that require the use of such SPVs (e.g. Murabahah or Ijarah) • The multiple contracts used in SPV structures must in combination meet the criteria for inclusion in capital. Eg. purchase undertaking must not legally or economically enhance the seniority of capital issued
Transparency & Clarity
Submission of: • Explanation of the salient features of the Shariah contract and Shariahcompliant mechanisms used in structuring the capital instrument • Confirmation that the write-off mechanism is Shariah-compliant, if the mechanisms other than those specified by SAC is used
Key features addressing Islamic financial transaction requirements
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
Separate compliance for Islamic banking windows
RWA calculations
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Investment Account as Risk Absorbent CAR for Islamic banks
Capital Base
=
Total RWA Less Credit and Market RWA funded by IA
Islamic Banking Act (IBA) Deposit include funds received under any contract Guidelines on Recognition & Measurement of PSIA as Risk Absorbent •
•
Risk absorbent only allowed for Restricted Investment Account (RIA) – loss fully transferred to PSIA holders No risk absorbent for Unrestricted Investment Account (URIA) because tools to manage Displaced Commercial Risks (DCR) is allowed eg. Profit Equalisation Reserves
Islamic Financial Services Act (IFSA) Funds with non-principal guarantee feature are defined as investment eg. Mudarabah, Musyarakah, Wakalah Investment Account Framework • •
Both RIA & URIA effectively & fully transfer loss to IA holders Full risk absorbent allowed as tools to manage Displaced Commercial Risks (DCR) is no longer allowed.
Only products structured as per IA Framework are eligible as risk absorbent 1 Product Structuring 6 • Product Disclosure Sheet • Terms & Conditions • Financial information disclosure
• Suitability & Fair dealing practices
2 • Separate management of IA
Transparency & Disclosure
5 Business & Market Conduct
• Shariah compliant • Redemption of investment account investment • Investment • Profit distribution objectives • Valuation
Manageme nt of IA
IA Framework
3 Oversight Arrangement
4 Risk Management & Internal Control
• Robust governance process to ensure effective oversight of investment mandate & strategies - Board - Shariah Committee - Senior Management
• Tagging capability facilitates measurement of risks & return • Appropriate identification & measurement of losses ensure effective risk transfer to IAH 21
PSIA as Risk Absorbent Look through approach IA Holder (Rabbul Mal) (e.g. parent bank)
No capital requirement for Mudarib as risks of underlying assets are transferred to Rabbul Mal
Fund placement
IA Manager (Mudarib) (e.g. Islamic subsidiary)
Capital requirement for Rabbul Mal is based on the underlying asset
Financing (i.e. underlying asset)
Credit Risk •
Under the standardised approach (SA), the Rabbul Mal shall calculate the capital requirement based on the risk weight applicable to the obligor of the underlying asset. Under the IRB approach, the Rabbul Mal shall calculate the capital requirements of the underlying asset.
Market Risk •
•
The Rabbul Mal shall classify the underlying asset as a trading book position based on its own trading book policy statement. Under the standardised approach, the Rabbul Mal shall use the appropriate capital charge of the underlying asset. Under the IMA, the Rabbul Mal shall calculate the capital requirements of the underlying asset.
22
The End
23
1
Outline • Background Development of Capital Adequacy Framework for Islamic Banks (CAFIB) • CAFIB requirements RWA calculation Capital component • Investment Account as risk absorbent
2
Capital Adequacy Framework for Islamic Banks (CAFIB) Implemented since 2008 Objectives: – to cater for specific structures of Islamic financial transactions; and – to standardise the approach in identifying and measuring risks for the computation of capital adequacy requirement Islamic banking institutions subject to the capital adequacy framework based on IFSB Capital Adequacy Standard (CAS) – Complement Pillar I of Basel II – Risk profiles & exposures determined based on underlying Shariah contracts (asset-based, lease-based & equity based): – Adopt risk measurements, covering credit risk, market risk & operational risk Minimum capital adequacy requirements of 8%, consistent with Basel requirement
Risk profile Shariah contracts contracts Shariah Trading book book instruments, instruments, Trading Forex, Commodities Commodities && Forex, Physical assets Physical assets
Risk exposures exposures & & Risk measurement measurement Credit risk; Market risk; and
Operational risk
Capital requirement Minimum of 8%
3
CAFIB: Further enhancements made in 2013 to cater for Basel III capital reform Revision made effective 1 Jan 2013 Objectives: – to raise the quality & consistency of the total capital – to cater for specific structures of Islamic capital instruments Enhancements – Capital base to be predominantly common equity Tier 1 (CET1 i.e. ordinary shares, retained earnings and reserves) – Other non-common equity capital instruments to be of higher quality – Deductions and prudential filters made via CET1 More granular minimum capital adequacy requirements
Capital Risk profile ratios 4.5% CET1 Shariah contracts 8% TC Trading book instruments, Forex, 10.5% TC&+Physical CCB In Commodities assets 2018 13% TC + CCyB
Risk exposures & Capital instruments measurement CET1 Additional Tier 1 Tier 2
Enhancing Risk Coverage (for Counterparty Credit Risk) - Stressed input - Credit Valuation Adjustment (CVA) - Central Counterparties (CCP)
Yet to be implemented
4
Basel III implementation timeframe for Malaysia
5
Key features addressing Islamic financial transactions
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Separate compliance for Islamic banking windows
RWA Calculations
• Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Risk Management
Scope: Islamic banking institutions & Islamic banking windows are subject to CAFIB Holding Company
Holding Company
Parent Bank (Conventional)
Islamic Bank (Domestic)
Islamic Bank (Foreign)
Islamic Banking Subsidiary
Conventional Bank
Islamic window
“Bank within a bank”
Subject to CAFIB
•
•
Separate minimum capital adequacy ratios at Islamic window level, in addition to compliance on consolidated basis at conventional bank level - i.e. Islamic window’s total capital (Islamic banking fund) must be at minimum 8 % of its total RWA Islamic window may raise its own capital e.g. via issuance of common equities or sukuk that qualify as CET1, AT1 or T2 - Conversion or write off of AT1 or T2 must be allocated to the Islamic banking fund
Key features addressing Islamic financial transactions
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Separate compliance for Islamic banking windows
RWA calculations
• Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Various Shariah contracts to support Islamic financial transactions Shariah Contracts
Fee Based
Equity Based
Sale Based • Murabahah (cost plus mark up) • Salam (forward sale) • Istisna` (construction/ manufacturing) • Ijarah (lease)
• Mudarabah (profit sharing & loss bearing) • Musharakah (profit & loss sharing)
• • • •
Wakalah (agency) Wadiah (safe keeping) Kafalah (guarantee) Rahnu (collateral)
Supporting Arrangements • Urbun (earnest money) • Hamish Jiddiyyah (security deposit) • Wa`d (undertaking) • Hibah (gift)
The Shariah contracts are applied to structure various Islamic banking products
Asset
Liability
Asset-based financing • Murabahah • Ijarah • Istisna
Investment Account • Mudarabah • Musharakah • Wakalah
Profit Sharing financing • Mudarabah • Musharakah • Wakalah
Islamic deposit • Wadiah • Qard • Tawarruq
The unique features of each Shariah contract entail different risk profile / exposure to Islamic banks… 9
Risk exposures are determined based on stages of Shariah contract Market Risk – based on type of risk eg. inventory risk, fx risk 1
Asset-based Sale and purchase contracts • Murabahah
Stages of contract Purchase of assets for sale or leasing
(mark-up sale)
• Salam (forward purchase)
• Istisna’ (Purchase of asset under construction)
Sell to customer on deferred payment terms
Leasing contracts
Or
• Ijarah • Ijarah Muntahia Bitamleek
Lease to customer
Risk exposure/ profile Market risk • Price risk arising from holding of assets Transform Credit risk • Sales or rental receivables due from counterparty
Credit Risk - Based on asset class eg. Sovereigns & Central Banks, Banking Institutions, Corporates, Regulatory Retail*, Residential Real Estate* * Applicable to Murabahah or Ijarah contracts. For recognition of other contracts, only allowed if credit risk profile is similar to Murabahah or Ijarah
Risk exposures are determined based on stages of Shariah contract Treated as equity exposure: ▪ 100% (publicly traded) ▪ 150% (non-publicly traded) Supervisory Slotting Criteria** ▪ RW ranging 70% to 400%
2
Profit sharing Joint venture/ partnership contract • Mudharabah (Profit sharing)
• Musharakah (Profit and loss sharing)
Stages of contract • Capital investment in commercial entities • Profits are shared based on agreed ratio • Losses are shared or borne by capital providers
Risk exposure/ profile Equity risk • Equity position in banking book - Capital impairment
Market risk • Equity position trading book - underlying assets
Treated as equity exposure: Specific & general risk charge depending on type of equity.
Murabahah
1 Asset held for sale
Stages of contract
Purchase Asset
2 Asset sold & payment due from obligor Sell Asset
Capital Treatment
Murabahah & Non-binding MPO1
Binding MPO
Credit Risk: None Market risk: 15% capital charge (x) exposure amount Credit Risk2: RW based on obligor’s ratings (x) exposure amount net MV of asset Market risk: None
1Murabahah 2 Assuming
Credit risk: RW based on obligor’s ratings (x) exposure amount Market risk: None Credit risk: RW based on obligor’s ratings (x) exposure amount
Market risk: None
for Purchase Orderer with non-binding Agreement to Purchase (AP) islamic bank has legal recourse to obligor for any shortfall after asset disposal
12
Operating Ijarah
Stages of contract
1 Purchase Asset
2
Asset held for lease
Lease Asset
3
Asset leased & rental due from lessee
End of lease period
Residual life of asset
Capital Treatment
NonBinding Agreement to Lease (AL)
Binding AL
Credit Risk: None Market risk: 15% capital charge (x) exposure amount
Credit Risk1: RW based on lessee’s ratings (x) exposure amount net MV of asset
Credit risk: RW based on lessee’s ratings (x) exposure amount net asset recovery value
Credit risk: None Market risk: 15% capital charge (x) exposure amount
Market risk: 8% capital charge on asset residual value
Similar as above
Market risk: None
1 Assuming
islamic bank has legal recourse to lessee for any shortfall after asset disposal
13
Ijarah Muntahia Bitamleek (IMB)
Stages of contract
1 Purchase Asset
2
Asset held for lease
Lease Asset
Asset leased & rental due from lessee
End of lease period & transfer of asset to lessee
Capital Treatment
NonBinding Agreement to Lease (AL)
Binding AL
Credit Risk: None Market risk: 15% capital charge (x) exposure amount
Credit Risk1: RW based on obligor’s ratings (x) exposure amount net MV of asset
Credit risk: RW based on obligor’s ratings (x) exposure amount net asset recovery value Market risk: None
Similar as above
Market risk: None
1 Assuming islamic bank
has legal recourse to lessee for any shortfall after asset disposal
14
Approach for market & operational risk Market Risk
Operational Risk
• Definition: - Market risk is defined as risk of losses in onand off-balance sheet positions arising from movements in market prices
• Definition: - Risk of losses resulting from inadequate or failed internal processes, people and systems or from external events - excludes strategic & reputational risks - includes Shariah compliance risk
• Types of market risk: – Benchmarking rate risk and equity risk : Capital charges are calculated based on Specific risk and General risk – Foreign exchange risk: Capital charge is calculated based on exposure to single currency and Portfolio mix – Commodity risk: 15% capital charge is applied based on either maturity ladder or simplified approach – Inventory risk: 15% capital charge is applied to assets held as inventory with a view to resale or lease More prevalent in Islamic financial transactions e.g. murabahah to purchase orderer or operating ijarah
More prevalent in Islamic financial transactions.
• Approaches: Basic Indicator Approach
Standardised/ Alternative Standardised Approach
Increased sophistication
Advanced Measurement
Key features addressing Islamic financial transaction requirements
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
Separate compliance for Islamic banking windows
RWA calculations
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Main changes for capital instruments
Basel I/II • Common Equity • Hybrid Tier 1 (Non-Inno Tier 1 & Inno Tier 1) • Tier 2 Subordinated instruments
Basel III • CET1 • Additional Tier 1 • Tier 2 Subordinated instruments
• Loss absorption limited to repayments terms & level of subordination • Step-ups allowed
• Principal loss absorption • Non-Viability Loss absorption • Step-ups not allowed
No specific treatment for Shariah compliant instruments
Treatment for Shariah compliant instruments clarified
Specific requirements on Shariah-compliant capital instruments
Shariah contracts
• Additional Tier 1 use only non-exchange based contracts (ie. Musyarakah & Mudarabah) • Due to perpetuality of instruments • No restrictions on type of Shariah contract for Tier 2 instruments
Loss absorption mechanism
• Conversion or write-off mechanism are allowed for exchange-based contracts (eg. conversion of sub-debt into ordinary shares) • Conversion mechanism for non-exchange-based contracts (eg. conversion of Additional Tier 1 into ordinary shares)
Use of SPV
• Use of an independent SPV is allowed in structures that require the use of such SPVs (e.g. Murabahah or Ijarah) • The multiple contracts used in SPV structures must in combination meet the criteria for inclusion in capital. Eg. purchase undertaking must not legally or economically enhance the seniority of capital issued
Transparency & Clarity
Submission of: • Explanation of the salient features of the Shariah contract and Shariahcompliant mechanisms used in structuring the capital instrument • Confirmation that the write-off mechanism is Shariah-compliant, if the mechanisms other than those specified by SAC is used
Key features addressing Islamic financial transaction requirements
• Scope
• Investment account (IA) holders absorb credit & market risks arising from assets funded by IA
Investment Account as Risk Absorbent
Application for Islamic financial transactions
Separate compliance for Islamic banking windows
RWA calculations
• Look-through approach from IA holder’s perspective Capital Instruments
• Types of Shariah contracts • Clarity on loss absorption mechanism
Risk exposures of Islamic financial transactions are determined based on underlying Shariah contracts
Investment Account as Risk Absorbent CAR for Islamic banks
Capital Base
=
Total RWA Less Credit and Market RWA funded by IA
Islamic Banking Act (IBA) Deposit include funds received under any contract Guidelines on Recognition & Measurement of PSIA as Risk Absorbent •
•
Risk absorbent only allowed for Restricted Investment Account (RIA) – loss fully transferred to PSIA holders No risk absorbent for Unrestricted Investment Account (URIA) because tools to manage Displaced Commercial Risks (DCR) is allowed eg. Profit Equalisation Reserves
Islamic Financial Services Act (IFSA) Funds with non-principal guarantee feature are defined as investment eg. Mudarabah, Musyarakah, Wakalah Investment Account Framework • •
Both RIA & URIA effectively & fully transfer loss to IA holders Full risk absorbent allowed as tools to manage Displaced Commercial Risks (DCR) is no longer allowed.
Only products structured as per IA Framework are eligible as risk absorbent 1 Product Structuring 6 • Product Disclosure Sheet • Terms & Conditions • Financial information disclosure
• Suitability & Fair dealing practices
2 • Separate management of IA
Transparency & Disclosure
5 Business & Market Conduct
• Shariah compliant • Redemption of investment account investment • Investment • Profit distribution objectives • Valuation
Manageme nt of IA
IA Framework
3 Oversight Arrangement
4 Risk Management & Internal Control
• Robust governance process to ensure effective oversight of investment mandate & strategies - Board - Shariah Committee - Senior Management
• Tagging capability facilitates measurement of risks & return • Appropriate identification & measurement of losses ensure effective risk transfer to IAH 21
PSIA as Risk Absorbent Look through approach IA Holder (Rabbul Mal) (e.g. parent bank)
No capital requirement for Mudarib as risks of underlying assets are transferred to Rabbul Mal
Fund placement
IA Manager (Mudarib) (e.g. Islamic subsidiary)
Capital requirement for Rabbul Mal is based on the underlying asset
Financing (i.e. underlying asset)
Credit Risk •
Under the standardised approach (SA), the Rabbul Mal shall calculate the capital requirement based on the risk weight applicable to the obligor of the underlying asset. Under the IRB approach, the Rabbul Mal shall calculate the capital requirements of the underlying asset.
Market Risk •
•
The Rabbul Mal shall classify the underlying asset as a trading book position based on its own trading book policy statement. Under the standardised approach, the Rabbul Mal shall use the appropriate capital charge of the underlying asset. Under the IMA, the Rabbul Mal shall calculate the capital requirements of the underlying asset.
22
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23
