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  • RM-2.1 RM-2.1 Definition and Profiles of Credit Risk

    • RM-2.1.1

      Credit risk is generally defined as the potential that a counterparty fails to meet its obligations in accordance with agreed terms. This definition is applicable to Islamic bank licensees managing the financing exposures of receivables and leases (for example, Murabahah, Diminishing Musharakah and Ijarah) and working capital financing transactions/projects (for example, Salam, Istisna` or Mudarabah1). Islamic bank licensees manage credit risks inherent in their financings and investment portfolios relating to default, downgrading and concentration. Credit risk includes the risk arising in the settlement and clearing of transactions.

      1 In cases where Mudarabah is used in project finance, a licensee advances funds to a customer who acts as Mudarib in a construction contract for a third-party customer (ultimate customer). The ultimate customer, who has no direct or contractual relationship with the licensee, will make progress payments to the Mudarib who in turn makes payment to the licensee. The role of the licensee is to provide bridging finance on a profit-sharing basis to the Mudarib pending its receipt of the progress payments from the ultimate customer. The licensee is exposed to credit risk on the amounts advanced to the Mudarib.

      January 2013

    • RM-2.1.2

      The following premises relate to the sound processes of credit risk management in an Islamic bank licensee:

      (a) The role of banks can embrace those of financiers, suppliers, Mudarib and Musharakah partners. Islamic bank licensees should concern themselves with the risk of a counterparty's failure to meet his obligations in terms of receiving deferred payment and making or taking delivery of an asset. A failure could relate to a delay or default in payment, or in delivery of the subject matter of Salam or Parallel Istisna', entailing a potential loss of income and even capital for the Islamic bank licensee;
      (b) Due to the unique characteristics of each financing instrument, such as the non-binding nature of some contracts, the commencement stage involving credit risk varies. Therefore, credit risk should be assessed separately for each financing instrument to facilitate appropriate internal controls and risk management systems; and
      (c) Islamic bank licensees should consider other types of risks that give rise to credit risk. For example, during the contract life, the risk inherent in a Murabahah contract is transformed from market risk to credit risk. In another example, the invested capital in a Mudarabah or Musharakah contract will be transformed to debt in case of proven negligence or misconduct of the Mudarib or the Musharakah's managing partner.
      Amended: April 2013
      January 2013