• CM-3 CM-3 Assessment of Credit Quality

    • CM-3.1 CM-3.1 Overview

      • CM-3.1.1

        A realistic assessment of credit quality is an essential feature of effective credit risk management. The starting point for a systematic review of credit quality is a comprehensive review of the bank's written credit policies and practices. These include, but are not limited to:

        (a) Credit approval procedures;
        (b) Credit underwriting criteria; and
        (c) Credit administration process.
        Amended: January 2011
        October 2007

      • CM-3.1.2

        Credit quality is a relative concept based on performance prospects and external variables. Trends in the economy, and changes in markets and prices of goods affect the evaluation of credit facility repayment value. Assessing credit risk is a dynamic concept which needs to take into account the business cycle and the economic environment.

        October 07

      • CM-3.1.3

        The objectives of the credit assessment are to determine:

        (a) Whether the applicant / customer will have sufficient future liquid resources to honour credit obligations according to the agreed terms;
        (b) Whether the applicant's / customer's present and future prospects indicate that they will continue as a going concern in the foreseeable future;
        (c) Is the applicant / customer of sufficient integrity; and
        (d) To what extent does any security offered affect the risk inherent in the facility.
        Amended: January 2011
        October 2007

      • CM-3.1.4

        To help improve prudential oversight of credit quality, the CBB, in this Module, seeks to establish a set of broad rules that are useful in identifying and containing the impact of impaired assets within banks.

        Amended: January 2011
        October 2007

    • CM-3.2 CM-3.2 Credit Grading System

      • CM-3.2.1

        The banks should have in place appropriate credit grading systems (classification) to help assess asset quality and credit exposures including performing receivables.

        October 07

      • CM-3.2.2

        Credit grading systems offer a number of benefits. Analysis of a bank's entire book can reveal important insights to bank's management in the functioning and ultimately the health of the bank. Credit grading systems provide the means for a more systematic assessment of asset quality. They are particularly useful in assisting in the early detection of asset quality problems within a bank by highlighting credit with above normal risks.

        October 07

      • CM-3.2.3

        The CBB does not favour the imposition of a standard credit grading system for all banks. Instead, the CBB will rely, wherever possible, upon the credit grading system adopted by each bank. This preference reflects the fact that banks generally have devoted significant resources to developing grading systems that best fit their individual product mix.

        Amended: January 2011
        October 2007

      • CM-3.2.4

        Each bank is hence required to provide to the CBB a statement of its current policy in respect of its credit grading system (including definitions used to classify exposures). Banks that do not intend to implement a credit grading system should indicate to the CBB their reason for not doing so. The CBB expects to have the endorsement of the Board of the bank concerned.

        Amended: January 2011
        October 2007

      • CM-3.2.5

        Banks looking to implement a credit grading system, or to update their current system, should consider the following points:

        (a) The system should cover a broad range of the bank's asset portfolio, including unrestricted investment accounts, restricted investment accounts and other off-balance sheet exposures;
        (b) The system should cover both performing and impaired assets - it is common for grading systems to have sufficient range of grades, covering exposures with the lowest risk to those where losses are expected;
        (c) Banks should detail credit grading system in a credit policy statement, and should develop procedures for the determination and regular review of the credit risk grades;
        (d) Banks should establish formal forums in the form of committees to review the compliance with the credit policy parameters and the concentration of exposure attributable to various economic and industrial sectors in accordance with the credit policy;
        (e) Particular attention should be given to those facilities which involve a higher than normal risk, or which are impaired;
        (f) It is imperative that the policies relating to the provisioning for Islamic banks should be clearly laid down, fully identifying provisions relating to assets financed by own funds and those by the investment account holders; and
        (g) Facilities should, at minimum, include four categories along the following lines:
        (i) 'Standard credits' are those, which are performing, as the contract requires. There is no reason to suspect that the creditor's financial condition or collateral adequacy has depreciated in any way. The bank is very likely to extend additional funds to this borrower if requested (subject to internal or legal credit restrictions);
        (ii) 'Substandard credits' are inadequately protected by the paying capacity of the obligor or by the collateral pledged. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of Substandard assets does not have to exist in individual assets classified Substandard;
        (iii) 'Doubtful credits' have all the weaknesses inherent in a credit classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable or improbable. The possibility of Loss is extremely high, but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the asset, its rating as an estimated Loss is deferred until its more exact status may be determined; and
        (iv) 'Loss credits' are considered uncollectible and of such little value that their continuance as assets is not warranted. The rating does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.
        Amended: April 2011
        October 2007

    • CM-3.3 CM-3.3 Impairment of Assets and Provisioning

      • Impairment of Assets

        • CM-3.3.1

          Banks are required to place on a non-accrual basis any facility where there is reasonable doubt about the collectability of the receivable irrespective of whether the customer concerned is currently in arrears or not. This acknowledges the reality that recognition of impaired assets will have a high degree of subjectivity attached to it.

          October 07

        • CM-3.3.2

          Impaired assets should be classified into one of the following categories:

          (a) Non accrual items;
          (b) Restructured items; or
          (c) Other assets acquired through security enforcement, including 'other real estate owned'.
          October 07

        • CM-3.3.3

          For the purpose of this Module, the following definition of non-accrual items applies:

          (a) Financing facilities and investments where there is reasonable doubt about the ultimate collectability of principal within a time frame established by the bank. Non-accruals would include all facilities against which a specific provision has been established, or a write-off taken even if the facility is not in breach of contractual requirements. Refer to AAOIFI's FAS 11 on recognition of provisions and reserves; and
          (b) Financing facilities and investments, not included in (a), where contractual payments of the principal are 90 or more consecutive days in arrears, and where the 'fair value' of security is insufficient to cover repayment. In line with the principles outlined above, a facility should be classified as non-accruing earlier than 90 days where it is evident that full, or partial repayment of the amount is unlikely even though the full extent of the loss cannot be clearly determined.
          Amended: April 2012
          October 07

      • Provisioning

        • CM-3.3.4

          Banks must maintain an adequate level of provisioning against the impairment of assets and problem exposures if their earnings and capital adequacy are to be measured correctly.

          October 07

        • CM-3.3.5

          As a general rule, where there is a doubt about the collectability of a receivable, and security exists, provisions should equal the carrying value of the receivable less the net current market value of security.

          October 07

        • CM-3.3.6

          Provisions of either type (specific or general) are made in relation to receivables, financing and investment assets in cases where there is doubt regarding collectability or an impairment of value. Refer to AAOIFI's FAS 11: Provisions and Reserves.

          October 07

        • CM-3.3.7

          Provisioning should be carried in the respective books including bank's own books, unrestricted investment account holders' books and restricted investment account holders' books.

          October 07

        • CM-3.3.8

          A general provision is an amount set aside to reflect a potential loss that may occur as a result of currently unidentifiable risks in relation to receivables, financing or investment assets. The amount reflects estimated losses affecting these assets attributable to events that have already occurred at the date of the statement of financial position, and not estimated losses attributable to future events.

          October 07

        • CM-3.3.9

          The policy for provisioning should clearly contain provisions for segregating provisions relating to assets financed by own funds and those financed by investment account holders. In devising the policy, reference should be made to the Mudaraba contract.

          October 07

        • CM-3.3.10

          A specific provision is an amount set aside to reflect an estimated impairment of value of a specific type of asset. In the cases of investment assets, it is the amount needed to write the assets down to cash equivalent value if this is lower than cost. Refer to AAOIFI's FAS 11: Provisions and Reserves.

          October 07

    • CM-3.4 CM-3.4 Provisions Against Sovereign Credit

      • CM-3.4.1

        The CBB has consistently encouraged banks to maintain adequate provisions against credits to borrowers experiencing difficulties and against credits for countries with current or potential credit servicing difficulties.

        Amended: January 2011
        October 2007

      • CM-3.4.2

        In all cases the assessment of credits - and decisions regarding adequate provisions - are assisted by the categorization of credits as defined by the CBB in Section CM-3.2. In addition, with regard to 'sovereign credit' it is particularly important that the size of the provisions made should be based on the identification and objective assessment of the nature and extent of difficulties being experienced by particular countries and reflect as near as possible deterioration in the prospects for recovering credits. With these objectives in mind, the Sovereign Credit Provisioning Matrix (see Appendix CM-1) contains a list of measurements which have been designed to help identify those borrowers and countries with payment difficulties and to decide what would constitute adequate provisions.

        Amended: January 2011
        October 2007

      • CM-3.4.3

        It is emphasized that this Section and the Sovereign Credit Provisioning Matrix (see Appendix CM-1) are merely a general framework for assessing degrees of provisions. They should not be regarded as an exhaustive or definitive framework. Nevertheless, the CBB does intend to include the results of banks' calculations in its discussions with them, and to establish that adequate provisions are being made.

        Amended: January 2011
        October 2007

      • Implications of International Accounting Standard (IAS) no. 39 on the Provisions Assessed through Sovereign Credit Provisioning Matrix

        • CM-3.4.4

          The banks must continue to apply the Sovereign Credit Provisioning Matrix (see Appendix CM-1) as a benchmark for estimating future recoverable cash receipts. However, if a lower provisioning amount is determined, i.e. lower than the amount identified through the matrix, and the bank intends to book the lower amount, then a meeting must be arranged with the CBB to discuss the issues before booking such provisions.

          Amended: July 2011
          Amended: January 2011
          October 2007

    • CM-3.5 CM-3.5 Collateral

      • CM-3.5.1

        The extension of credit is often supported by collateral provided by the customer or third parties. When the credit decision is based on collateral value, independent timely appraisals of the collateral should be obligatory, including provision for sufficient security margins.

        October 07

      • CM-3.5.2

        In principle, collateral can improve the credit grading of a customer, but experience suggests that over-reliance on collateral is unsound because very often when a credit facility goes sour the collateral turns out to have less value than estimated or is, at worst, illusory.

        October 07

      • CM-3.5.3

        Misjudgements about collectability are frequently the cause; collateral is often illiquid, difficult to value during periods of financial distress and costly to realise through foreclosure or other legal means. Particular concern may be appropriate in the case of collateral in the form of real estate, as it involves additional uncertainties and the costs of maintaining the property.

        October 07

      • CM-3.5.4

        As a matter of principle, collateral should not replace a careful assessment of the borrower's ability to repay.

        October 07

    • CM-3.6 CM-3.6 Country and Transfer Risks

      • CM-3.6.1

        The CBB requires all Islamic bank licensees to set out their policy on country and transfer risks, including the criteria on downgrading a country exposure from stage 1 to stages 2 or 3, and related provisioning requirements, in a policy statement which must be approved by the CBB.

        Added: July 2017

      • CM-3.6.2

        For the purpose of Paragraph CM-3.6.1, Islamic bank licensees , may consider the sovereign risk matrix factors, stipulated in Appendix CM-1 (Sovereign Debt Provision Matrix), and any other factors.

        Added: July 2017

      • CM-3.6.3

        Branches of foreign Islamic bank licensees must satisfy the CBB that equivalent arrangements are in place at the parent entity level, otherwise a policy statement is required in line with paragraph CM-3.6.1.

        Added: July 2017

      • CM-3.6.4

        The policy statement set in Paragraph CM-3.6.1 must be implemented with effect from 1st January 2018.

        Added: July 2017