- 1. Fahad Zafar MBA (Bradford, UK),BSc (Middlesex,
UK),Certificate: Islamic Banking (State Bank,
Pakistan),Certificate: Risk Management (ESC Toulouse, France).
Mayfair Business Consultants Lahore, Pakistan
2.
- Risks are uncertain future events which could influence the
achievement of the banks objectives:
3.
- O my children, do not enter capital of Egypt by one gate but go
into it by different gates. However know it well that I cannot ward
off you Allahs will for none other than He has nay authority
whatsoever. In Him I have put my trust and all who want to rely
upon anyone should put their trust in Him alone.
4.
- Prophet (PBUH) once asked a Bedouin who had left his camel
untied, Why do you not tie your camel? The Bedouin answered, I put
my trust in God.
- Prophet (PBUH) then said, tie up your camel first then put your
trust in God.
5. Shariah ComplianceIs the essence ofIslamic Finance Objective
Fulfillment e.g. Promote justice, fairness & protection of
human necessity (Shariah) Minimizing Risk e.g. Mitigate Shariah Non
compliant risk at decision making level as well as operational
level. Alternatives e.g. Alternative to Riba based activities. 6.
Shariah Governance Shariah Committee Audit Committee Shariah
Advisor AAOIFIGovernance Standards SBP Guidelines IFSB Standards
7.
- Risk management is the process by which various risk exposures
are:
-
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- Mitigated and controlled,
8.
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- Encompasses senior management and BOD
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- Within a business area or across business lines
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- On-the-line risk management.
9. BANK CAPITAL Depositors Counter-parties Linkages with other
balance sheets Linkages with other balance sheets Contingent claims
Funding side risks Asset side risks 10. ISLAMIC BANKS TRADITIONAL
BANKS Tier 1 Capital (equity) Tier 1 Capital (equity) Tier 2
Capital (?) Tier 2 Capital (Subordinated loans) Current accounts
Current accounts Saving accounts Interest-based Saving accounts
Unrestricted Profit Sharing Investment Accounts (PSIAs) Time &
certificates of deposits Profit equalization reserves (PER)
ReservesInvestment risk reserve (IRR) 11. 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 liabilitiesonly in case of
fiduciary risks(theory);
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- Profit Equalization Reserve (PER)
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- Investment Risk Reserve (IRR)
Shareholders equity and subordinated loans protect these
liabilities against all risks Cost of funds: Variable Cost of
funds: Fixed 12. Uses of Funds ISLAMIC BANKS Cash & balances
with other banks Sales Receivables(Murabaha, Salam, Istisnaa)
Investment securities Musharakah financing Mudaraba financing
Investment in real estate Investment in leased asset Inventories
(including goods for Murabaha) TRADITIONALBANKS Cash & balances
with other banks Loans Mortgages Financial leases Investment in
real estate Securities 13.
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- Islamic Financial Service Board (IFSB)
14.
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- Guidelines on Risk Management
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- BSD Circular #7, 15 thAug 2003.
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- Guidelines on Internal CRR Systems
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- BSD Circular #8, 29 thOct 2007.
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- Risk Management Guidelines for IBIs
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- IBD Circular #1, 2 ndJan 2008.
15.
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- Guidelines on Stress Testing
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- BSD Circular #5, 27th Oct 2005.
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- Guidelines on Internal Controls
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- BSD Circular #7, 27th May 2004.
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- BSD Circular #1, 14th Jan 2006.
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- Policy Framework in Banks
16.
- 15 Guiding Principles, divided into:
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- Credit risk(4 Principles)
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- Equity investment risk (3 Principles)
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- Liquidity risk(2 Principles)
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- Rate of return risk(2 Principles)
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- Operational risk(2 Principles)
17.
- These principles are not radically different from those
applicable to conventional banks.
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- Emphasis on Shariah compliance.
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- 6 out of 15 principles make explicit reference to Shariah
rules.
18.
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- Review of policy & procedures.
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- Designing of scoring models.
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- Post facto review/ analysis.
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- Risk related reports for RMC.
19. RMD IBSD RMC Risk Identification Risk Analysis &
Assessment Risk Monitoring Understanding Risk & Risk Management
20.
- Does Islamic banking risk differ fromConventionalbanking
risk?
- Not different - just a very special case
-
- Asset backed Secured or unsecured ?
- Islamic Banking is about who bears risk!
21.
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- Islamic Banking is safer as it is not based on Interest!
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- Depositors are liable to share losses, therefore solvency risk
is mitigated!
22. Askari Bank (Islamic) Sharia non Compliance Risk Displaced
Commercial Risk Equity Investment Risk Rate of Return Risk Credit
Risk Market Risk Liquidity Risk Operational Risk Legal Fiduciary
Reputation Strategic Transparency Regulatory compliance Generic
Unique 23.
24.
- Even generic risks are not straight forward.
- For financing that involves financing assets e.g.
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- Murabaha, Salam, Istisna and Ijarah.
-
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- The risks of financing may transform from credit to market and
vice versa at different stages of the contract.
- Hence capital requirement needs to take into account both the
credit and market risk.
25.
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- Bank sells assets it already owned to customer at cost plus
something.
- Murabaha Purchase Ordered (MPO)
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- Bank sells assets it acquires to customer at cost + based on
promise to purchase (PP) by customer.
26.
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- Asset available for sale (asset on balance sheet).
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- Assets is sold to and payment is due from customer.
27.
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- Asset available for sale (asset on balance sheet).
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- Asset is sold to and payment is due from customer.
28.
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- Bank owns the assets whilst transferring the right to use the
asset to lessee. Liabilities & risk pertaining to the asset is
born by bank.
- Ijarah Muntahaia Bittamleek
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- Bank promise to transfer the asset by sale or hibah & must
be separately expressed and independent of underlying Ijarah.
29.
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- Asset available for lease (prior to signing of a lease
contract).
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- Upon signing a leasing contract and the asset is available for
lease.
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- Maturity of contract term and the leased asset is returned to
the bank.
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- Upon signing a leasing contract and the asset is available for
lease.
30.
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- Asset available for lease (prior to signing of a lease
contract).
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- Upon signing a leasing contract and the asset is available for
lease.
31.
- Shariah Non-Compliance Risk
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- Risk arises from the failure to comply with the Shariah rules
and principles.
- Displaced Commercial Risk
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- The risk that the bank may confront commercial pressure to pay
returns that exceed the rate that has been earned on its assets
financed by investment account holders.
-
- The bank foregoes part or its entire share of profit in order
to retain its fund providers and dissuade them from withdrawing
their funds.
-
- The risk arising from entering into a partnership for the
purpose of undertaking or participating in a particular financing
or general business activity as described in the contract, and in
which the provider of finance shares in the business risk.
-
- The risk is relevant under Mudarabaha and Musharakah
contracts.
32.
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- The potential impact on the returns caused by unexpected change
in the rate of returns.
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- Associated with the management of assets &
liabilities.
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- Fixed rate long term assets funded by variable rate short term
liabilities.
-
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- Movement in benchmark rates may result infund providers having
expectations of a higher rate of return.
-
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- If Islamic bank does not yield to market pressure, they may
lose their fund providers which could consequently lead to
liquidity risk.
33. Gross Income Net Distributable Income Income from Investment
Income from Financing Income from IMM Investing Less: Net trading
Income and other income. Financing and investment loss provision.
Profit Equalization Reserve Direct Expenses Depositor Islamic Bank
Profit Sharing Ratio 34. Customer Askari Bank (Islamic) Depositors
Revenue Financing Dividend/ Hibah Deposit 35.
- Asset-backed transactions
- Profit Sharing Transactions
- Special Investment Accounts
Restricted Investments Direct Investors Balance Sheet Off
Balance Sheet 36.
- Six, full fledge Islamic banks.
- Twelve, conventional banks having Islamic banking windows/
branches.
37. 38. Is Askari Banks Portfolio similar to the Islamic Banking
Industry outlook! Banking Industry Islamic Banks Share of Islamic
Banks # Rs (Million) # Rs (Million) # Rs (Million) Corporate 26,061
1,520,130 1,959 62,784 7.5% 4.1% SME 185,039 437,351 2,685 12,535
1.5% 2.9% Agriculture 1,415,353 150,777 159 13 0.0% 0.0% Consumer
Finance 3,025,463 371,421 36,533 28,843 1.2% 7.8% Commodity Finance
2,616 148,447 31 1,118 1.2% 0.8% Others126,021 72,758 1,148 2,459
0.9% 3.4% Total 4,780,553 2,700,883 42,515 107,752 0.9% 4.0%
39.
- The previous table shows that consumer finance, with a share of
more than 25% in the total credit base of Islamic Banks, is almost
totally concentrated in
- This is because Islamic banking is based on asset-backed
transactions.
40.
- Lack of exposure to Unsecured products has actually insulated
Islamic Banks from the adverse impact of the weakening
Macroeconomic environment, in which the borrowers ability to
service their loans can be potentially impaired.
41.
- Non Performing Financing (NPF) to Financing.
- Net NPFs to Net Financing.
- Net NPFs to Total Capital
42.
- Diminishing Musharaka 25.6%
Source: SBP Strategy Paper 43. Providing an architecture that
governs theoverall risk management philosophy and strategy Acting
as a foundation to allow management of risksto be conducted most
effectively in line withthe industrys best practices Setting a tone
for the philosophical & practicalapproaches in managing risk
44.
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- Management Awareness and Self Assessment.
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- Key Risk Indicators (KRI).
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- Portfolio/ Exposure Tracking.
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- Sector Analysis of loans.
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- Large Exposure to individuals and connected parties.
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- Loan and other asset classification and provisioning.
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- Analysis of loans in arrears.
45.
- Shariah Non Compliance should be one of our Key Risk Indicator
(KRI) parameter.
46.
- Appropriate Credit Strategy, including:
-
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- Tolerance for undertaking various credit risks.
- A credit risk management structure with effective oversight of
credit risk management.
- An appropriate measurement and careful analysis of exposures,
including market & liquidity sensitive exposures.
47.
- High level documents which cut across various silos of risk to
establish the Enterprise wide Risk Management Framework in the
bank.
48.
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- Risk Appetite of the Bank.
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- The banks plan to grant credit based on the following:
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- Various Client Segments & Products,
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- The Target Market within each lending segment, preferred level
of diversification/ concentration.
49.
- Detailed & formalized credit evaluation/ appraisal
process.
- Credit Approval Authority at various levels of hierarchy,
including Exceptions. E.g.
- Risk identification, measurement, monitoring &
control.
- Risk acceptance criteria.
- Credit origination & credit administration and loan
documentation procedures.
- Roles & responsibilities of staff involved in origination
& management of credit.
- Guidelines on management of problem loans. (off-loading
etc).
50.
- Risk appetite determines risk exposure.
- Risk diversification & asset allocation strategies
applicable to each
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- Islamic financing instrument.
51.
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- The expected rate of return on a transaction is commensurate
with the risks incurred.
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- Following are managed effectively:
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- (individual & portfolio levels)
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- Excessive Risk Concentration
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- E.g. financing instruments, economic activity, geographical
spread.
52.
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- To monitor the condition of ongoing individual credits to
ensure the financings are made in accordance with the policies
& procedures.
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- To manage problem credit situations according to an established
remedial process.
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- To ensure adequate provisions are allocated.
53.
- Take into account seasonal aspects resulting from a shifting or
termination of use of certain financing instruments, thus affecting
the overall concentration exposures of the financing
portfolio.
-
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- Bank may offer Salam contracts during a certain season where a
product can most likely be delivered & sold at maturity .
54.
- The due diligence process may include:
- Enforcement & economic substance of the proposed project,
including:
55.
-
- Bank should engage appropriate technical experts:
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- to evaluate the feasibility of a proposed new project.
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- To assess and approve progress billings to be made under the
contract.
56.
- Appropriate methodologies for measuring and reporting the
credit risk exposures arising under each Islamic instrument.
57.
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- Pledge of assets as collateral.
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- Inventories, Shares, Sukuk, Unis, etc.
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- Parallel contract, if permissible.
58.
- Methodology for setting markup rates according to risk rating
of the counterparties.
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- Pricing as per expected risks.
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- Permissible & enforceable collateral & guarantees.
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- Clear documentation as to whether or not purchase orders are
cancelable.
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- Clear procedures for taking account of governing laws for
contracts relating to financing transactions.
- Limits on the degree of reliance.
- Enforceability of collateral & guarantees.
-
- Usage, redemption & utilization of collateral if the
counterparty defaults in payment.
- Necessary action incase a customer cancels a non-binding
purchase order.
59.
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- Enforceability of collateral.
- Inability to use penalty rates as a deterrent against late
payments could create both higher risk of default and longer delays
in repayments.
60.
- If leased assets are impaired through no default of Lessee,
then bank would:
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- Provide Lessee with a replacement asset with similar
specifications.
-
- Proper risk management policy to mitigate losses arising from
such damage, during the term of the lease.
61.
- Ensure Shariah compliant insurance coverage of the value of the
assets.
62.
- Bank bears the risks associated with the leased assets and
cannot use lessees guarantees to recover the amount of the losses
on the leased assets, unless these are due to:
63.
- A policy for determining and allocating provisions:
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- Doubtful debts including counterparty exposures.
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- Estimated impairment in value of leased assets.
64.
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- Bank enters Istisna contract as sellers to provide manufactured
goods or a building to a customer.
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- Then bank enters into another parallel Istisna contract as
buyers with a supplier (manufacturer or builder), using
specifications drawn up for the original contract.
-
- If the supplier fails to deliver the manufactured goods or the
building according to the agreed specifications, Bank would be in
default of their obligation.
65. Thanks A lot! Fahad Zafar Mayfair Business Consultants
Lahore, Pakistan.