facilitating the implementation of ifsb standards fis workshop series © islamic financial services...

FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS

FIS WORKSHOP SERIES

© ISLAMIC FINANCIAL SERVICES BOARD© ISLAMIC FINANCIAL SERVICES BOARD

1

Workshops onFacilitating the Implementation of IFSB Standards

CAPITAL ADEQUACY STANDARDFOR Institutions ( Other than Insurance Institutions)

Offering only Islamic Financial Services

Cairo, Egypt27 – 28 August 2008

All rights reserved. No part of this publication may be reproduced, translated, stored in or introduced into a retrieval system or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of the Islamic Financial Services Board.


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Case Study

Measurement of Capital

Adequacy Ratios of an IIFS


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Learning Objectives

Participants will be able to:

Understand the background for and context of the IFSB-CAS

Identify and classify the risks associated with Shari’ah compliant

instruments

Define data requirements for:

o the key calculations for the relevant approaches and;

o the main exposure types

Execute the basic calculations for the capital adequacy formulas


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Methodology

Capital adequacy ratios using IFSB and Basel II are calculated

based on:

Type of Risk Basel approach

Credit Risk Standardised Approach

Market Risk 1996 Market Risk Amendments

(Standardised Measurement Method)

Operational Risk Basic Indicator Approach


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AssumptionsCredit Risk

1. All International Murabahah and Wakalah attract a RW of 50%, as they represent transactions with high credit quality rated international banks with residual maturity up to 3 months

2. Murabahah and Ijarah (in local currency) treated under preferential risk weights

50% of Murabahah & Ijarah are for retail business; and

50% of Murabahah & Ijarah are over collectivized by RRE

3. Investment in Government Musharakah Sukuk are treated as Sukuk held in the banking book

4. No past due receivable


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Assumptions cont’d

Market Risk

5. For inventories, book values = market values of the commodities at spot market prices

6. Residual value of assets leased = amount receivable from operating Ijarah less 10% depreciation

Sources of Funds

7. Percentage of assets funded by unrestricted PSIA is 27%


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Balance Sheet

• To Identify risks associated

with Shari’ah compliant

products

• To classify risks


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Assets

Cash & cash equivalent (local) 7,640,300,010.54

Cash & cash equivalents (foreign) 3,666,429,588.06

Correspondents A/Cs 5,319,257,257.77

Account Receivables

International Murabahah (foreign) 47,395,740,416.74

Wakalah (foreign) 13,232,002,133.74

Murabahah (local) 21,198,540,883.65

Istisnaa 7,190,999.45

Ijarah 2,589,290,037.89

Qard 839,980,349.77

Diminishing Musharakah 2,297,075,300.36

Mudarabah 147,785,420.15

Properties held for sale 179,733,023.67

Investments

Investment in Govt. Musharakah Sukuk 18,257,778,137.78

Investment in equities (subsidiaries) 1,804,968,610.01

Other assets 2,956,549,000.00

Fixed Assets 4,742,207,616.78

Total On-balance sheet items 132,477,828,786.36

Off/balance sheet items 30,573,255,130.56

Total assets 163,051,083,916.92

Liabilities

Current Accounts (local) 33,095,265,730.85

Current Accounts (Foreign) 51,134,349,148.22

Other A/Cs (foreign) 492,485,700.62

other A/Cs (local) 33,492,930.20

Sub-total 84,755,593,509.89

Unrestricted investment accounts (local) 26,040,775,217.25

Unrestricted investment accounts (foreign) 9,374,904,225.32

Sub-total 35,415,679,442.57

Other liabilities 4,462,923,826.89

Owner equities 7,843,632,007.01

Total on-balance sheet items 132,477,828,786.36

Contingent liabilities

Acceptance Commitments 7,435,832,969.93

L/Gs commitments 1,645,478,824.17

L/Cs Commitments 10,891,835,984.49

Other commitments 10,600,107,351.97

Total Liabilities 163051083916.92


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Basel I

Calculation of capital adequacy ratio: A brief reminder


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IFSB-CAS

Calculation of Capital Requirements for Credit Risk


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Ref Category Exposure RWA CARCapital Requirements for

Credit Risk

Form C2 RWA for individual claims based on ECA 0 0.00 8% 0.00

Form C 3 RWA for short-term exposures & other assets 71,618,530.00 42,452,896.50 8% 3,396,231.72

Form C 4 RWA for exposures under profit sharing mode 18,257,778.00 0.00 8% 0.00

Form C 5RWA for exposures with preferential risk weights 23,787,830.00 13,083,306.50 8% 1,046,664.52

Form C 6 RWA for past due receivables 0.00 0.00 8% 0.00

Form C 7 RWA for Off-balance sheet exposures 30,573,255.00 20,057,015.74 8% 1,604,561.25

Total 144,237,393.00 75,593,218.74 6,047,457.50


FORM C1: Summary Table for Credit Risk Capital Requirements


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Exposure Type Rating RW Original Exposure

Credit Risk Mitigation Techniques

RWA

Supervisory Haircut Simple Approach

Amount of collateral Haircut % Adjusted

Collateral Net

Exposure RW of counterparty

1 2 3 4 5 6 7 8 9

4 ( 1 - 5 ) ( 3 - 6 ) (3 x 2) or (7 x 2) or (3 x 8)

Short-term ExposureA-1/P-1 20%

International Murabahah & Wakalah* A-2/P-2 50% 60,627,742.00

30,313,871.00

A-3/P-3 100%

Diminishing Musharakah others 150% 2,297,075.00

3,445,312.50

Mudarabah Unrated 100% 147,785.00 147,785.00

Istisna Unrated 100% 7,191.00 7,191.00

Qard Unrated 100% 839,980.00 839,980.00

Other assets 100% 2,956,549.00 2,956,549.00

Fixed Assets 100% 4,742,208.00 4,742,208.00

Total Exposure 71,618,530.00 42,452,896.50

FORM C3: RWA for Short-term Exposure and Other Assets


Refer to slide (5) - assumptions


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Exposure Type Rating RW Original Exposure

CRM

RWSimple Approach

RW of counterparty

1

2

3

4 5

(3x2) or (3x4)

Mudarabah Simple Method

300%

Govt. Musharakah Sukuk 400% 18,257,778.00 0%* 0

Joint Ownership of real estate and movable assets Slotting method

90%

100%

135%

270%

Total 18,257,778.00 0


FORM C 4: RWA for Investments made under Profit sharing Mode

* Assuming RW of Govt. is zero


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A Exposure Type RWAmount of Exposure

Value of Collateral **

Haircut % ***Value of eligible

collateral Net

ExposureRWA

1 2 3 4 5 6 7

3 ( 1 - 4) (2 - 5) (2 x 1 ) or (6 x 1)

1Murabahah or Ijarah collateralized by residential real estate

35%11,893,915.00 4,162,870.25

2Murabahah or Ijarah collateralized by Commercial real estate

50%

100%

3Murabahah and/or Ijarah receivables from individuals or small business (retail)

75%11,893,915.00

8,920,436,25

Total 23,787,830.00 13,083,306.50

* Preferential Risk Weights if the underlying assets are sold under Murabahah or leased under Ijarah

** collaterals other than real estate such as Hamish jiddiah or Urbon

*** Cash collateral in foreign currencies subject to a haircut of 8%


FORM C 5: RWA for Exposures with Preferential Risk Weights*


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FORM C 7: Off-balance Sheets Exposures

Exposure CCF Outstanding Amount

Credit Equivalent

Adjusted collateral

Net Exposure RW RWA

1 2 3

( 1 x 2)

4 5

( 3 – 4)

6 7

(5 x 6)

L/Cs collateralized by underlying shipments / goods

20% 10,891,836 2,178,367 450,677 1,727,690 100% 1,727,690

≤ 1 year commitments 20% 1,645,479 329,095 35,710 293,385 100% 293,385

≥ 1 year commitments 50%

others 100% 18,035,940 18,035,940 0 18,035,940 100% 18,035,940

Total 30,573,255 20,543,402 486,387 20,057,015 20,057,015


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Calculation of Capital Requirements for Market Risk

IFSB-CAS


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Ref. ExposureCapital

Requirements CF* RWA

Form D2 Total Equity Risk Capital Charge 0 0 12.5 0

Form D3Total Specific Risk Capital Charge for Sukuk positions 0 12.5

Form D4Total General Risk Capital Charge for Sukuk and off-balance sheet financial instruments 12.5

Form D5 Total foreign exchange capital charge ** 271,804.80 12.5 3,397,560.00

Form D6 Total commodity risk capital charge 12.5 0

Form D7 Total inventory risk capital charge 2,776,214.00 213,504.00 12.5 2,668,800.00

Total 485,308.80 12.5 6,066,360.00

* reciprocal of minimum capital adequacy ratio

** This balance can be checked from the position in foreign currency


FORM D 1: Summary of Market Risk Capital Requirements


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Currency Net Spot Position 1

Net Forward Position2

Guarantees3 Other Items4 Net Long Position or Net Short Position

US dollar (-) 27,891.74 27,891.7 0.0

Saudi Riyal (+) 3,357,303.91 3,357,303.9

Jordanian Dinar 0.0 0.0

Qatar Riyal (-) 77.63 77.6 0.0

Sterling P (+) 40,257.30 40,257.3

Euro (-) 867,583.83 867,583.8 0.0

UAE Dirham (-) 372.16 372.2 0.0

Oman Riyal (-) 23.41 23.4 0.0

Bahrai Dinar (-) 22.41 22.4 0.0

Total Position 895,971.2 3,397,561.2

X Y

Net Gold Position

Z

Capital charge calculation

Greater of Net Long Position (X) or absolute value of Net Short

Position (Y)

Absolute value Net Gold or Silver

Position (Z)

Capital Requirement Total Capital Charge

3,397,561.2 0.0 8% 271,804.80


FORM D 5: Foreign Exchange Risk Capital Charges


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Book Value

Market Value Capital Charge Capital requirement

Properties held for sale 179,733.00 179,733.00 15% 26,960.00

Salam (without parallel Salam) 15%

Unbilled WIP inventory under Istisna without parallel Istisna

7,191.00 7,191.00 1.6% 115.10

Residual value of assets leased* 2,589,290.00 2,330,361.00* 8% 186,428.90

Total 2,776,214.00 2,517,285.00 213,504.00


FORM D 7: Inventory Risk Capital Charges

*Assuming 10% depreciation , See slide (6) - Assumptions


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Calculation of Capital Requirements for Operational Risk

IFSB-CAS


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2004 2005 2,006

Net income from financing activities 1,459,000 2,582,000.00 4,903,000.00

Net income from investment activities 22,000.00 68,000.00 76,000.00

Fee income (e.g. commission and agency fee) 578,000 1,413,000 2,547,000

2,059,000.00 4,063,000.00 7,526,000.0 13,648,000

Less

Investment account holders' share of income 340,000.00 715,000.00 1,632,000 2,687,000

Gross income 1,719,000.00 3,348,000.00 5,894,000 10,961,000

Average Gross Income 3,653,666.67

Assigned Capital Charge 15%

Capital requirement for operational risk 548,050.00

Conversion factor 12.5

Operational Risk Weighted Assets 6,850,625


FORM E: Operational Risk


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Calculation of Eligible Capital

IFSB-CAS


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Tier 1 Capital Amount Tier 2 Capital Amount

Issued and fully paid ordinary shares/common stock 7,000,000 Asset revaluation reserve 275,025 611,167

Perpetual non-cumulative preference shares General provisions

Share premium Hybrid capital instruments

Legal reserves 240,705 Subordinated debt of more than 5 years

Retained profit

Less:

Goodwill

TOTAL 7,240,705 275,025

Tier 1 + Tier 2 = 7,515,730

Less : Investment in subsidiaries = 1,804,969

Total Eligible capital = 5,710,762

Calculation of Eligible Capital

FORM F: Eligible Capital

Ratio of Tier 2 to Tier 1 = 3.8%


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Calculation of CA ratios

Comparison:

IFSB formula

Basel II formula

Basel I formula


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IFSB Formula Basel II formula Basel I Formula

a)Total eligible regulatory capital which is used as the numerator for CAR

5,710,762.00 5,710,762.00 5,710,762.00

b) Total RWA for credit risk 75,593,218.74 75,593,218.7432,513,792.00

c) Total RWA for market risk 6,066,360.00 6,066,360.00 6,066,360.00

d) Sub-total 81,659,578.7481,659,578.74 38,580,152.00

e) Total RWA for operational risk 6,850,625.00 8,530,000.00

Total RWA 88,510,203.74 90,189,578.74 38,580,152.00

f) RWA (CR & MR) funded by profit sharing investment account holders 22,048,086.26

RWA (CR & MR) funded by restricted investment account holders 00 00

RWA (CR & MR) funded by unrestricted investment account holders 27% 22,048,086.26

RWA (CR & MR) funded by PER and IRR

g) Minimum Capital Adequacy Requirements

h) Total RWA - RWA funded by unrestricted PSIA( CR + MR) ( e – f)66,462,117.48

o) Standard Formula 8.6% 6.3% 14.8%

p) Supervisory Formula

Calculation of Capital Adequacy Ratios


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Group Exercise 4

Analyses:The Impact of Balance Sheet Structure onCapital Adequacy Ratio


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Balance sheet Structure of Hypothetical Banks

25

5

10

8

13

40

1

Assets Liabilities

15

50

25

10

1

Other

Mudarabah

Musharakah

Istisna

Ijarah

Murabahah

Large PSIA portfolio

Significant Musharakah and

Mudarabah exposure

Source: Modified from McKinsey

Bank A

Other

CA + SA

PSIA

Equity


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35

25

853

25

1

Balance sheet Structure of Hypothetical Banks cont’d

15

15

60

10

1

Assets Liabilities

Limited PSIA within deposit base

Limited Musharakah and Mudarabah

exposure


Bank B

Other

Mudarabah

Musharakah

Istisna

Ijarah

Mudarabah

Other

CA + SA

PSIA

Equity


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35

15

10

10

5

25

1

15

15

60

10

1

Other

CA + SA

PSIA

Equity

Other

Mudarabah

Musharakah

Istisna

Ijarah

Murabahah

Limited PSIA within deposit base

Significant Musharakah and

Mudarabah exposure


Balance sheet Structure of Hypothetical Banks cont’d

Bank C

LiabilitiesAssets


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Thank you …


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Mashair Mohammed Ibrahim

Assistant Project Manager

Islamic Financial Services Board

3rd Floor Block A, Bank Negara Malaysia Building

Jalan Dato’ Onn, 50480 Kuala Lumpur, Malaysia

P.O.Box 10591, 50714 Kuala Lumpur, Malaysia

Telephone: 603 – 26984248 ext. 135

Fax: 603-26984280

e-mail: [email protected]

Contact information


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Summary of Capital Requirements for Shari’ah Compliant Contracts

ContractRisk weights

Credit Risk** Market Risk CR + MR

Murabahah Inventory Asset delivered to a counterparty

N.A.100%

187.5%N.A.

187.5%100%

Salam Salam without parallel Salam Salam with Parallel Salam

100%100%

187.5%287.5 % + 24%

287.5%< 287.5%

Istisna Istisna without parallel Istisna Istisna with parallel Istisna

100%100%

20%N.A.

120%100%

Ijarah Inventory Operating Ijarah IMB

N.A.100%100%

187.5%100%N.A.

187.5%200%100%

Musharakah 300% - 400%90% - 270%

Depends on the underlying assets

≥ ( 300% - 400%)≥ ( 90% - 207%)

Mudarabah 300% - 400%90% - 270%

Depends on the underlying assets

≥ ( 300% - 400%)≥ ( 90% - 207%)

* Capital charges do not include operational risk

** Provided the counterparty is unrated, otherwise the RW of the counterparty should be applicable

Capital Charges*

15%8%

23%< 23%

9.6%8%

15%16%8%

≥ (24% - 36%)≥ (7.2% - 21.6%)

≥ (24% - 36%)≥ (7.2% - 21.6%)

facilitating the implementation of ifsb standards fis workshop series © islamic financial services...

Documents

receivable slide

murabahah ijarah

iifs slide

market values

assumptions credit risk

assumptions contd market

capital adequacy formulas

cash cash equivalents