RM-6.3 RM-6.3 Operational Considerations
RM-6.3.1
Islamic bank licensees must establish a comprehensive risk management and reporting process to assess the potential impacts of market factors affecting rates of return on assets in comparison with the expected rates of return for IAHs.January 2013RM-6.3.2
Islamic bank licensees must take necessary steps to ensure that the management processes relating to the identification, measurement, monitoring, reporting and control of the rate of return risk (including appropriate structure) are in place. Since the rate of return risks are emanating from various balance sheet positions,Islamic bank licensees must recruit competent staff to undertake the analysis of risk exposures arising from their consolidated balance sheet activities.January 2013RM-6.3.3
Islamic bank licensees must be aware of the factors that give rise to rate of return risk. The primary form of rate of return risk to which theIslamic bank licensees are exposed comprises increasing long-term fixed rates in the market. In general, profit rates earned on assets reflect the benchmark of the previous period and do not correspond immediately to changes in increased benchmark rates.January 2013RM-6.3.4
Islamic bank licensees must assess the effect of the level of their dependency on current account holders' funds. Although no returns are expected by current account holders, the sudden withdrawal of these funds would have an adverse impact on the overall potential rate of return forIslamic bank licensees .January 2013Rate of Return Risk Management
RM-6.3.5
Islamic bank licensees must implement appropriate systems for identifying and measuring the factors which give rise to rate of return risk.January 2013RM-6.3.6
When calculating a rate of return,
Islamic bank licensees must employ a gapping method for allocating positions into time bands with remaining maturities or re-pricing dates, whichever is earlier. Fixed and floating rate assets ofIslamic bank licensees must be classified according to their receivable dates because the returns on these receivables represent the fund providers' direct and beneficial ownership of the assets.January 2013RM-6.3.7
Actual cash flows may indicate a gap for a given time band, affecting the rate of return for that period. Depending on the complexity and the nature of their business operations,
Islamic bank licensees may employ techniques ranging from simple gap to advance simulation or dynamic approaches to assess future cash flow variability and net income. The estimates derived from selected approaches may provide acceptable approximations of periodic future earnings' variability; hence, the outcomes will yield different levels of expected returns to IAHs.January 2013RM-6.3.8
The measurement of rate of return risk highlights the importance of cash flow forecasting for instruments and contracts where
Islamic bank licensees are required to simulate and assess their behavioral maturity, underlying assumptions and parameters, which must be reviewed periodically for reliability. The materiality of potential threats to future earnings and the usefulness of the resulting information must be considered in determining the type and extent of forecasted behavior forIslamic bank licensees .January 2013RM-6.3.9
In assessing whether a potential threat is likely to have a material, likely and imminent impact on a balance sheet position,
Islamic bank licensees must ensure that they understand the different characteristics of their balance sheet positions in the different currencies and jurisdictions within which they operate.January 2013RM-6.3.10
In assessing exposure to rate of return risks,
Islamic bank licensees must take into account the non-contractual behavioral maturity of the transactions in the context of the environment in which they operate and changing market conditions.January 2013RM-6.3.11
With reference to Paragraph RM-6.3.10, in case of early repayment made by the customer (in Murabaha or Ijara transactions),
Islamic bank licensees may accept full settlement but give rebates on subsequent transactions, while in other cases, theIslamic bank licensees may give rebates immediately at their discretion without any reference to this in the contract.January 2013RM-6.3.12
Islamic bank licensees are encouraged to employ balance sheet techniques to minimize their exposures using the following strategies, among others:(a) Determining and varying future profit ratios according to expectations of market conditions;(b) Developing new Shari'a-compliant instruments; and(c) Issuing secuntisation tranches of Shari'a permissible assets.January 2013Displaced Commercial Risk Management
RM-6.3.13
Islamic bank licensees must have in place an appropriate framework for managing displaced commercial risk, where applicable.January 2013RM-6.3.14
Islamic bank licensees must have in place a policy and framework for managing the expectations of their shareholders and IAHs. Where market rates of returns of competitors' IAHs are higher than those ofIslamic bank licensees ' IAHs, theIslamic bank licensees must evaluate the nature and extent of the expectations of its IAHs and assess the amount of the gap between competitors' rates and their own IAHs' expected rates.January 2013RM-6.3.15
Islamic bank licensees must develop and maintain an informed judgment about an appropriate level of the balances of PER, bearing in mind that its essential function is to provide mitigation of displaced commercial risk. SomeIslamic bank licensees must maintain the proportion relating to IAHs in this reserve within the IAHs equity, with the purpose of smoothing returns to IAHs, and in particular, to enhance their returns if these are below those of competitors. This implies that there will be years in which the balance of this reserve will be increased, and others in which it will be depleted.January 2013
