Capital Adequacy Framework for Islamic Banks - Bank Negara

477 Pages·2012·1.47 MB·English

Capital Adequacy Framework
for Islamic Banks
(Risk-Weighted Assets)
Issued on: 28 November 2012
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

PART A  OVERVIEW................................................................................1 
A.1  EXECUTIVE SUMMARY............................................................1 
A.2  APPLICABILITY........................................................................3 
A.3  LEGAL PROVISION..................................................................3 
PART B  CREDIT RISK ............................................................................4 
B.1   INTRODUCTION........................................................................4 
B.2   THE STANDARDISED APPROACH FOR CREDIT RISK.........6 
B.2.1   EXTERNAL CREDIT ASSESSMENTS......................................6 
B.2.2  DEFINITION OF EXPOSURES................................................11 
Exposures to Sovereigns and Central Banking institutions......11 
Exposures to Non-Federal Government Public Sector Entities
(PSEs)......................................................................................13 
Exposures to Multilateral Development Banking institutions
(MDBs).....................................................................................14 
Exposures to Banking Institutions and Corporates...................14 
Exposures to Takaful Companies, Securities Firms and Fund
Managers .................................................................................18 
Exposures Included in the Regulatory Retail Portfolio..............18 
Financing Secured by Residential Real Estate (RRE) Properties
.................................................................................................20 
Exposures Secured by Commercial Real Estate (CRE)...........22 
Defaulted Exposures................................................................22 
Higher Risk Assets...................................................................23 
Other Assets.............................................................................24 
B.2.3  TREATMENT FOR THE COMPUTATION OF CREDIT RISK-
WEIGHTED ASSETS FOR ISLAMIC CONTRACTS...............25 
MURĀBAHAH ..........................................................................26 
BAI’ BITHAMAN AJIL (BBA) AND BAI’ INAH...........................28 
IJĀRAH.....................................................................................28 
SALAM.....................................................................................31 
ISTISNĀ`..................................................................................33 
MUSHĀRAKAH........................................................................35 
MUDĀRABAH ..........................................................................38
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

QARDH ....................................................................................41 
SUKŪK.....................................................................................41 
B.2.4  OFF-BALANCE SHEET ITEMS...............................................42 
B.2.5  CREDIT RISK MITIGATION ....................................................45 
Minimum Conditions for the Recognition of Credit Risk Mitigation
Techniques...............................................................................46 
Credit Risk Mitigation Techniques............................................47 
Other Aspects of Credit Risk Mitigation....................................65 
B.3   THE INTERNAL RATINGS BASED APPROACH...................66 
B.3.1  ADOPTION OF THE IRB APPROACH....................................66 
Adoption of IRB Across Asset Classes.....................................66 
Implementation Timelines and Transition Period......................70 
Determination of Capital Requirements under the IRB approach
.................................................................................................72 
B.3.2  CATEGORIES OF EXPOSURES.............................................75 
Definition of Corporate Exposures, including Specialised
Financing..................................................................................75 
Definition of Bank Exposures ...................................................79 
Definition of Retail Exposures ..................................................79 
Definition of Equity Exposures..................................................82 
Definition of Purchased Receivables Exposures......................84 
B.3.3  RISK COMPONENTS..............................................................86 
Risk Components for Corporate, Sovereign and Bank
Exposures ................................................................................86 
Risk Components for Retail Exposures....................................98 
Risk Components for Equity Exposures.................................100 
B.3.4  CREDIT RISK MITIGATION (CRM).......................................101 
Minimum Conditions for the Recognition of Credit Risk Mitigation
Techniques.............................................................................102 
Collateralised Transactions....................................................102 
Guarantees.............................................................................115 
On-Balance Sheet Netting......................................................122 
Other Aspects of Credit Risk Mitigation..................................123 
B.3.5  RISK-WEIGHTED ASSETS...................................................125
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

Risk-Weighted Assets for Corporate, Sovereign and Bank
Exposures ..............................................................................125 
Risk-Weighted Assets for Retail Exposures...........................129 
Risk-Weighted Assets for Equity Exposures ..........................131 
Risk-Weighted Assets for Purchased Receivables.................136 
Risk-Weighted Assets for Leasing..........................................142 
B.3.6  CALCULATION OF MINIMUM CAPITAL REQUIREMENT...143 
Regulatory Capital..................................................................143 
Calculation of Expected Losses .............................................144 
Calculation of Provisions........................................................147 
Risk-Weighted Assets............................................................147 
Parallel Calculation.................................................................148 
Prudential Capital Floor..........................................................148 
B.3.7  MINIMUM REQUIREMENTS FOR THE IRB APPROACH....150 
Rating System Design............................................................151 
Rating System Operation.......................................................164 
Risk Estimation.......................................................................171 
Governance, Oversight and Use of Internal Ratings..............202 
Validation of Rating Systems and Internal Estimates.............208 
B.3.8  QUALIFICATION...................................................................217 
Overview of Approval and Review Process............................217 
General Qualification Process................................................217 
Home-Host Supervisory Issues..............................................219 
Changes to IRB Implementation and Adoption.......................220 
PART C  OPERATIONAL RISK............................................................222 
C.1  INTRODUCTION....................................................................222 
C.1.1  SOUND PRACTICES FOR OPERATIONAL RISK
MANAGEMENT.....................................................................222 
C.2  THE BASIC INDICATOR APPROACH (BIA)........................223 
C.3  THE STANDARDISED APPROACH AND ALTERNATIVE
STANDARDISED APPROACH .............................................226 
C.3.1  THE STANDARDISED APPROACH (TSA)...........................226 
C.3.2  THE ALTERNATIVE STANDARDISED APPROACH (ASA) 230
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

PART D  MARKET RISK ......................................................................235 
D.1  INTRODUCTION....................................................................235 
Scope of the Capital Charges.................................................235 
Approaches of Measuring Market Risks.................................236 
Standardised Approach..........................................................236 
Internal Models Approach.......................................................236 
D.1.1  PRUDENT VALUATION GUIDANCE....................................237 
Systems and Controls............................................................237 
Valuation Methodologies........................................................238 
Independent Price Verification................................................239 
Valuation Adjustments............................................................240 
D.1.2  CLASSIFICATION OF FINANCIAL INSTRUMENTS............240 
Trading Book Policy Statement..............................................241 
Definition of Trading Book......................................................242 
Classification of Specific Financial Instruments......................244 
D.1.3  TREATMENT OF MONEY MARKET INSTRUMENTS IN
TRADING BOOK...................................................................245 
Controls to Prevent Regulatory Capital Arbitrage...................245 
Treatment of Hedging Positions.............................................247 
D.1.4  TREATMENT OF COUNTERPARTY CREDIT RISK IN THE
TRADING BOOK...................................................................248 
D.2  THE STANDARDISED MARKET RISK APPROACH............249 
D.2.1  BENCHMARK RATE RISKS.................................................249 
Specific Risk...........................................................................250 
Specific Risk Capital Charges for Issuer Risk ........................250 
General Benchmark Rate Risk...............................................253 
Offsetting of Matched Positions..............................................254 
Maturity Method......................................................................254 
Vertical Disallowance.............................................................255 
Horizontal Disallowance.........................................................255 
Duration Method.....................................................................257 
Treatment of Profit Rate Derivatives, Sell and Buy Back
Agreement (SBBA) and Reverse SBBA Transactions............259
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

Example 1: Calculation of General Risk (Maturity Method) for
Benchmark Rate Related Financial Instruments ....................265 
D.2.2  EQUITY POSITION RISK ......................................................269 
Specific and General Risk......................................................269 
Specific Risk...........................................................................269 
General Risk...........................................................................270 
D.2.3  FOREIGN EXCHANGE RISK (INCLUDING GOLD AND
SILVER POSITIONS).............................................................272 
The Treatment of Structural Positions....................................272 
Measuring the Exposure in a Single Currency .......................273 
The Treatment of Profit, Other Income and Expenses in Foreign
Currency.................................................................................274 
Measuring the Foreign Exchange Risk in a Portfolio of Foreign
Currency Positions.................................................................275 
D.2.4  COMMODITIES RISK............................................................276 
Simplified Approach................................................................278 
Maturity Ladder Approach......................................................278 
Models for Measuring Commodities Risk...............................281 
D.2.5  INVENTORY RISK.................................................................285 
Murabahah and Murabahah for Purchase Order (MPO)........285 
Istisna’....................................................................................286 
Ijarah and Ijarah Muntahia Bittamleek (IMB) ..........................287 
Operating Ijarah......................................................................289 
Ijarah Muntahia Bittamleek (IMB)...........................................289 
D.2.6  TREATMENT OF OPTIONS..................................................291 
Underlying Position Approach................................................291 
Simplified Approach................................................................293 
Delta-Plus Method..................................................................295 
Scenario Approach.................................................................298 
Example 4: Delta-Plus Methods for Options...........................299 
Example 5: The Scenario Approach for Options ....................305 
D.3  INTERNAL MODELS APPROACH........................................310 
D.3.1  COMBINATION OF INTERNAL MODELS AND THE
STANDARDISED MARKET RISK MEASUREMENT
APPROACH...........................................................................310
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

D.3.2  QUALITATIVE STANDARDS................................................313 
D.3.3  QUANTITATIVE STANDARDS .............................................316 
D.3.4  SPECIFICATION OF MARKET RISK FACTORS..................318 
D.3.5  MODELLING OF SPECIFIC RISK.........................................322 
D.3.6  STRESS TESTING.................................................................326 
D.3.7  MODEL VALIDATION STANDARDS....................................328 
D.3.8  MODEL REVIEW...................................................................330 
D.3.9  FRAMEWORK FOR THE USE OF BACK TESTING.............331 
PART E  LARGE EXPOSURE RISK REQUIREMENTS.......................340 
E.1   LERR FOR ISLAMIC BANKING INSTITUTIONS..................340 
Appendix I  Eligibility Criteria for External Credit Assessment Institution
(ECAI) Recognition.................................................................341 
Appendix II  Summary of Risk Weights for Financing Secured by
Residential Real Estate (RRE) Properties..............................347 
Appendix III  Definition of Default......................................................348 
Appendix IIIa  Diagrammatic Illustration of Re-ageing via Restructuring
352 
Appendix IV  Illustration on Risk-Weighted asset (RWA) Calculation for
Defaulted Exposures and Exposures Risk-Weighted at 150%
353 
Appendix V  Minimum Requirements on Supervisory Slotting Criteria
Method...................................................................................355 
Appendix Va  Supervisory Slotting Criteria for Specialised Financing
Exposures ..............................................................................361 
Appendix VI  Counterparty Credit Risk and Current Exposure Method
381 
Appendix VIa  Sample Computation of Risk-Weighted Capital
Requirement and Exposure at Default (EAD) for a Portfolio of
Derivative Contracts...............................................................388 
Appendix VIb  “Add-on” Factors for Derivatives Contracts...............390 
Appendix VIc  Example for Calculation of Residual Maturity.............393 
Appendix VId  Discount Factor and Range of Residual Maturity.......394
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

Appendix VII  Capital Treatment for Failed Trades and Non-DvP
Transactions...........................................................................395 
Appendix VIII  List of Recognised Exchanges*.................................400 
Appendix IX  Recognition Criteria for Physical Collateral Used For
Credit Risk Mitigation Purposes of Islamic Banking Exposures
402 
Appendix X  Summary Table of Gross Income Computation............408 
Appendix XI  Mapping of Business Lines..........................................409 
Appendix XII  Illustration of the Offsetting Rules Between Negative and
Positive OR Capital Charge in Any Business Lines................410 
Appendix XIII  Detailed Loss Event Type Classification....................411 
Appendix XIV  Illustration of Computation of Exposures with Credit Risk
Mitigation Effects....................................................................413 
Appendix XV  Information Requirements for Application to Adopt the
Internal Ratings Based Approach for Credit Risk...................416 
Appendix XVI  Information Requirements for Application to Adopt the
Internal Models Approach for Market Risk..............................419 
Appendix XVII  Illustration of Computation of Large Exposure Risk
Requirement...........................................................................425 
Appendix XVIII  Capital Treatment for Sell and Buyback Agreement
(SBBA)/ Reverse SBBA Transactions....................................428 
Appendix XIX  IRB Coverage............................................................431 
Appendix XX  Assessment of Credit Risk based on Shariah Contracts
434 
Appendix XXI  The “Look-Through” Approach for Specific and Loss-
Bearing Fund Placement........................................................448 
Appendix XXII  Transitional Arrangements and Approval Process....451 
Appendix XXIII  Credit Conversion Factors for Off-Balance Sheet Items
under the IRB Approach.........................................................457 
Appendix XXIV  Illustrative IRB Risk Weights...................................459 
Appendix XXV  Potential Evidence of Likely Compliance with the Use
Test 462 
Appendix XXVI  Data-Enhancing and Benchmarking Tools..............463
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Islamic Banks
Takaful Department (Risk-Weighted Assets)

Appendix XXVI  Illustration on the treatment of underwriting exposures
467
BNM/RH/GL 007-21 Islamic Banking and Capital Adequacy Framework for Page
Takaful Department Islamic Banks (Risk-Weighted Assets) 1 / 469

PART A OVERVIEW
A.1 EXECUTIVE SUMMARY

1.1 The Capital Adequacy Framework for Islamic Banking institutions (Risk-
Weighted Assets) (the Framework) specifies the measurement methodologies
for the purpose of calculating Risk-Weighted Assets (RWA) for credit risk,
market risk and operational risk as follows:
Risk Type Available Approaches
1. Credit Risk (cid:131) Standardised Approach
(cid:131) Internal Rating Based (IRB) Approach*
2. Market Risk (cid:131) Standardised Approach
(cid:131) Internal Models Approach (IMA)*
3. Operational Risk (cid:131) Basic Indicator Approach (BIA)
(cid:131) Standardised Approach (TSA)*
(cid:131) Alternative Standardised Approach (ASA)*
* Subject to explicit approval by Bank Negara Malaysia (the Bank). For IRB
Approach, only applicable for adoption from 1 January 2010.

1.2 The Framework should be read together with the Capital Adequacy
Framework for Islamic Banking institutions (Capital Components) and shall
form the basis for the computation of the capital adequacy ratios.

1.3 The formulation of the Framework is consistent with the Capital Adequacy
Standard for Institutions other than Insurance Institutions offering only Islamic
Financial Services (CAS) issued by the Islamic Financial Services Board
(IFSB) and the Capital Adequacy Framework (Basel II – Risk-Weighted
Assets) issued by the Bank for banking institutions licensed under Banking
and Financial Institutions Act 1989 (BAFIA).

1.4 Some customisations have been effected to the requirements set out in CAS
to ensure suitability of the Framework in the local environment and apply
consistent treatment across banking industry for common risk exposure in
order to prevent any potential regulatory arbitrage.