Durham Islamic Autmun Summer School, 2011 in Istanbul Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 1 1 Presented at the Durham Islamic Finance Autumn School 2011 jointly organised by Durham Centre for Islamic Economics and Finance and ISARIstanbul Foundation for Research and Education Istanbul Commerce University, Istanbul 19 th 22 nd September 2011 Asset & Liability Management : challenges facing Islamic financial institutions Majdi Chaabouni 2 Seminar « Asset & liability Management in the Islamic Banks» July 2011 Majdi Chaabouni: Biography and conferences participation 2011
Transcript
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 1
1!
Presented at the Durham Islamic Finance Autumn School 2011 jointly organised by Durham Centre for Islamic Economics and Finance and ISAR-‐Istanbul Foundation for Research and Education Istanbul Commerce University, Istanbul 19th-‐22nd September 2011
2. Explain the main objectives and the goals to achieve in the ALM
10 minutes – 5 July 2011
3. Understand how to identify the ALM risk in the conventional and Islamic bank
10 minutes – 5 July 2011
4. Understand how to measure and manage the ALM risk: conventional bank versus Islamic banks
10 minutes - 5 July 2011
5. Conclusion on the indicators and measurement techniques to be used by Islamic banks
10 minutes – 5 July 2011
Seminar “Asset & Liability Management in islamic banks”, July 2011– Majdi Chaabouni
t
4!
Asset & Liability Management in the conventional bank!
Part 1: The conventional bank & the techniques for the balance-sheet management
4!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 3
5!
01 Liquidity risk: let’s suppose a bank has the following structure…
6!
01 Liquidity risk: let’s suppose a bank has the following structure…
Excess of liquidity
Need for financing
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 4
7!
01 Liquidity Gap
For every maturity
GAP (T) = Liability (T) – Asset (T)
- If GAP >0 à more resources than a need for financing
- If GAP <0 à the real concern
Liquidity risk: Liquidity GAP as a measure of the risk
8!
01 Illustrative example to clarify the ideas
- Asset side:
- Loan infine: 2 years maturity; nominal 100 Euro with fixed rate 5%
- Liability side:
- Borrowing over 1 year; nominal 80 Euro for 3%
- Capital 20 Euro
What is the Liquidity Gap?
What is the Interest rate Gap?
Interest rate risk: Interest rate GAP as a measure of the risk
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 5
9!
01 Interest rate risk: Interest rate GAP as a measure of the risk
10!
01 Illustrative example to clarify the ideas
Let’s take the same example BUT with variable rates
- Asset side:
- Loan infine: 2 years maturity; nominal 100 Euro with fixed rate 5% for the first year and
variable for the 2nd year
- Liability side:
- Borrowing over 1 year; nominal 80 Euro for 3%
- Capital 20 Euro
What is the Liquidity Gap?
What is the Interest rate Gap?
Interest rate risk: Interest rate GAP as a measure of the risk
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 6
11!
01 Interest rate risk: Interest rate GAP as a measure of the risk
12!
01 In summary: Only transactions with fixed interest rate risk are the origin of the risk We can say that the Interest rate GAOP is equal to: Difference between transactions with fixed interest rate: } by maturity } Asset vs Liability } Another way to say it as well: Interest rate Gap = Liquidity Gap for fixed rate transactions à Indeed : Variable rate ⎝ there is no extrac-cost for financing
Interest rate risk: Interest rate GAP as a measure of the risk
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 7
13!
Asset
Let’s take an example to illustrate the ALM (Balance-sheet ) risk… The Gap is the simplest technique to measure the risk 01
Liability
Capital 10,000,000 Cost for establishment 500,000
Buildings 500,000
Mortgage Loans 10,000,000 (Fixed rate 15 yrs)
Bond issue 5,000,000 (Fixed rate 15 yrs)
Mortgage Loans 5,000,000 (Fixed rate 15 yrs)
Loan from FIs 15,000,000 (Fixed rate 1 year)
Mortgage Loans 15,000,000 (Fixed rate 15 yrs)
Loan from FIs 15,000,000 (variable rate 7 yers)
Mortgage Loans 15,000,000 (Fixed rate 7 yrs)
Cost for establishment 500,000
Buildings 500,000
Mortgage Loans 10,000,000 (Fixed rate 15 yrs)
14!
Asset
01
Liability
Capital 10,000,000
Bond issue 5,000,000 (Fixed rate 15 yrs)
Mortgage Loans 5,000,000 (Fixed rate 15 yrs)
Loan from FIs 15,000,000 (Fixed rate 1 year)
Mortgage Loans 15,000,000 (Fixed rate 15 yrs)
Loan from FIs 15,000,000 (variable rate 7 yers)
Mortgage Loans 15,000,000 (Fixed rate 7 yrs)
Le Profit is volatile…& exposed to interest rate risk!
Let’s take an example to illustrate the ALM (Balance-sheet ) risk… The Gap is the simplest technique to measure the risk
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 8
15!
The ALM (balance-sheet) risk Example of Interest rate risk 02
Let’s consider the following balance-sheet as of 1st January 2006 : Asset side : • Loan to retail customers:
• nominal : 1000
• duration : infine reimbursement with a maturity of 1 year
• rate : MMRate (ex. Libor) + 2 %
Liability side : • Capital (shareholders fund):
• amount : 200
• Reimbursement : indeterminate by the shareholders
• borrowing from the money market :
• amount : 800
• Reimbursement : infine over 6 months
• rate : MMR + 1%
let’s supose the MMR is 5 %
16!
02 As of 1st Jan 2006 the balance-sheet has the following shape:
ASSET LIABILITY
Loans 1000 Capital 200
Borrowing from FIs 800
Total LIABILITY 1000 Total ASSETS 1000
In summary : The Balance-sheet is equilibrated as of today (1st Jan 2006) The Bank has 200 of capital & 800 of borrowing placed in retail customers loans (commercial portfolio)
The ALM (balance-sheet) risk Example of Interest rate risk
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 9
17!
02 As of 1st Jan 2006 the balance-sheet has the following shape:
ASSET - Loans to customers LIABILITY - Capital - Money Market
ALM risk: computation of the interest rate margin (IRM)
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 11
21!
02 We can eliminate the risk of volatility of the Margin using derivative products We can eliminate these risks by putting in place :
ð Swap contract with a notional amount of 200 ð Forward Rate agreement (FRA) : - Nominal 800; maturity 3rd trimester This FRA will generate unique cash flows on the 3rd trimester : ¼ x 800 x (r – 5.5%)
- Nominal 800; maturity 4th trimester This FRA will generate unique cash flows on the 3rd trimester ¼ x 800 x (r – 6%) Let’s suppose that forward rate are equal to 5.5% and 6% respectively for 3rd
trimester and 4th maturity based on the yield curve
ALM risk: there are possbilities for hedging with derivative products
Seminar “Asset & Liability Management in islamic banks”, July 2011– Majdi Chaabouni 22!
t Asset & Liability Management in the Islamic bank!
Part 2: The Islamic bank & the techniques to manage the balance-sheet
22!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 12
23!
01 The principle of banking is the intermediation of risks on different maturities: can we say that Islamic bank is doing the doing the intermediation of risks as well?
Funding side risks
Asset side risks BANK CAPITAL D
epos
itors
Cou
nter
-pa
rties
Link
ages
with
oth
er b
alan
ce s
heet
s
Link
ages
with
oth
er b
alan
ce s
heet
s
Contingent claims
Banking is about intermediation of short-term risks
01 The balance-sheet ou ALM risks existent even in the islamic bank
1. Depositors: May withdraw;
2. Banks: Tend to accumulate assets to maximize return on equity;
3. Counter-parties: May default;
4. Regulators: Seek banking soundness;
5. Other companies and households within the interlinked balance sheets, have contingent claims on each other and
6. Public/tax payers: Faces the cost of deposit protection and financial crisis.
24!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 13
25!
01 The Islamic Bank : The resources Identification of resources of funds (1/2)
ISLAMIC BANKS TRADITIONAL BANKS
Tier – 1 Capital (equity) Tier – 1 Capital (equity)
Tier – 2 Capital (?) Tier – 2 Capital (Subordinated loans)
01 ISLAMIC BANK TRADITIONAL BANK Current accounts Current accounts Banks in both cases use shareholders’ equity to protect these deposits Profit sharing investment accounts (PSIA)
Time deposits, certificates of deposits, etc – fixed income liabilities Shareholders’ equity protects
these liabilities only in case of fiduciary risks (theory); Profit Equalization Reserve (PER) & Investment Risk Reserve (IRR)
Shareholders’ equity and subordinated loans protect these liabilities against all risks
Cost of funds: Variable Cost of funds: Fixed
The Islamic Bank : The resources Identification of resources of funds (2/2)
26!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 14
01
ISLAMIC BANKS Cash & balances with other banks Sales Receivables (Murabaha, Salam, Istisna’a) Investment securities Musharaka financing Mudaraba financing Investment in real estate Investment in leased asset Inventories (including goods for Murabaha)
Uses of Funds TRADITIONAL BANKS Cash & balances with other banks Loans Mortgages Financial leases Investment in real estate Securities
The Islamic Bank : The allocation of funds Identification of the usage of funds/resources
27!
01 The Islamic bank : investment A/Cs…innovation but complexity and very specific
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
32!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 17
02 Islamic modes of finance:
Unique risk factors • Liquidity originated market risk • Transformation of credit risk to market risk and
market risk to credit risk at various stages of a contract
• Bundling of credit risk and market risk • Market risk arising from owning the underlying non-
financial asset until maturity of a contract or until the ownership is transferred to customer
• Treatment of default
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
33!
02 Unique balance sheet features of IBs from market risk perspective …(1/2)
• In traditional banks, market risk is mostly in the trading book
• In Islamic banks, market risk is concentrated in the banking book due to Murabahah, Ijara, Salam, Musharakah and Mudharabah in the banking book asset portfolio
• Hence it is unique for Islamic banks that market risk and credit risk are strongly bundled together
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
34!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 18
02
Liabilities Assets Capital PSIAs Current accounts
10 50 40
Murabahah Istisna Ijarah Salam Musharakah Mudharabah
70 10 10 4 3 3
Total 100 100 The
se a
re n
ot r
e-pr
ice-
able
The
se a
re r
e-pr
ice-
able
Unique balance sheet features of IBs from market risk perspective …… (2/2)
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
35!
02 Assumption: 1 % increase in benchmark price
IB 1 IB 2 IB 3
L A L A L A Re-price-able 10 10 10 4 5 5 Non-re-price-
able 0 0 0 6 5 5
Balance Sheet value change
.10 .10 .10 -.02 0 0
Asset value change
0 ?
-.12 ? 0 ?
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
36!
Durham Islamic Autmun Summer School, 2011 in Istanbul
Majdi Chaabouni- The Risk Exposure of Asset & Liability Management in Islamic Financial Institutions 19
02
• Treatment of default: In Islam, compensation-based restructuring of credit is the most well known form of Riba, namely, Riba Al Jahiliyah – this highly necessitates credit risk management
• Moral issues in loan loss reserves • Collateral quality (restrictions on use of sovereign
bonds) • Insurance – clients’ insurance and facilities
insurance • Diverse modes and bundled risks
Unique credit risk features of IBs ….(1/2)
The Islamic Bank : very specific area…specific way to manage the balance-sheet and the ALM risk
