CA-3.5.1

This Section sets out the minimum capital requirement to cover counterparty risk and residual value risk of leased assets, arising from an Islamic bank licensee entering into contracts or transactions that are based on the Sharia rules and principles of Ijarah and Ijarah Muntahia Bittamleek (IMB), also known as Ijarah wa Iqtinā. The Section also covers the market (price) risk of assets acquired for Ijarah and IMB.

CA-3.5.2

In an Ijarah contract (either operating or IMB), the Islamic bank licensee as the lessor maintains its ownership in the leased asset whilst transferring the right to use the asset, or usufruct, to an enterprise as the lessee, for an agreed period at an agreed consideration. All liabilities and risks pertaining to the leased asset are to be borne by the Islamic bank licensee including obligations to restore any impairment and damage to the leased asset arising from wear and tear and natural causes which are not due to the lessee's misconduct or negligence.

CA-3.5.3

Thus, in both Ijarah and IMB, the risks and rewards remain with the lessor, except for the residual value risk at the term of an IMB which is borne by the lessee. The lessor is exposed to price risk on the asset while it is in the lessor's possession prior to the signature of the lease contract, except where the asset is acquired following a binding promise to lease as described in Paragraph CA-3.5.12.

CA-3.5.4

In an IMB contract, the lessor promises to transfer its ownership of the leased asset to the lessee at the end of the contract as a gift or as a sale at a specified consideration, provided that (a) the promise is separately expressed and independent of the underlying Ijarah; or (b) a gift contract is entered into conditional upon fulfilment of all the Ijarah obligations, and thereby ownership shall be automatically transferred to the lessee.

CA-3.5.5

In both operating Ijarah and IMB, the Islamic bank licensee either possesses the asset before entering into a leased contract or enters into the contract based on specific description of an asset to be leased and acquired in the future before it is delivered to the lessee. The agreement to lease may be considered as binding (binding Promise to Lease (PL)) or as non-binding (non-binding PL) depending on the applicable terms and conditions.

CA-3.5.6

This Section sets out the minimum capital requirements to cater for the lessor's exposures to (a) the credit risk of the lessee as counterparty in servicing the lease rentals, and (b) the market (price) risk attaching to the residual value of the leased assets either at the end of the Ijarah contract or at the time of repossession upon default, i.e. the risk of losing money on the resale of the leased asset.

CA-3.5.7

In IMB, once the lease contract is signed, the lessor is exposed to credit risk for the lease payments receivable from the lessee (a credit risk mitigated by the asset's value as collateral¹⁴ in most cases) and to a type of operational risk in respect of the need to compensate the lessee if the asset is permanently impaired through no fault of the latter. If the leased asset is permanently impaired and is uninsured, the Islamic bank licensee suffers a loss equal to the carrying value of the leased asset, just as it would if any of its fixed assets were permanently impaired. In the event that the lessee exercises its right to cancel the lease, the lessor is exposed to the residual value of the leased asset being less than the refund of payments due to the lessee. In such case, the price risk, if any, is already reflected in a 'haircut' to be applied to the value of the leased asset as collateral. Therefore, the price risk, if any, is not applicable in the context of the IMB.

¹⁴ The collateral used in the context of IMB is of the usufruct or use value of the asset, as the bank is the owner of the asset.

CA-3.5.8

The credit risk exposure in respect of the lease rentals is mitigated by the collateral represented by the value of the leased asset on repossession, provided that the Islamic bank licensee is able to repossess the asset, which may be subject to doubt, especially in the case of movable assets. Insofar as there is doubt as to the lessor's ability to repossess the asset, the residual value of the asset that was assumed in fixing the lease rentals is also exposed to credit risk.

CA-3.5.9

The Islamic bank licensee may be exposed to losses in case a lessee acquiring an asset under IMB decides not to continue with the contract. The lease contract may give the lessee this right subject to certain conditions (such as a minimum period of notice). In such a case, the lessor is required to refund to the lessee the capital payments (instalments of the purchase price) that were included in the periodic lease rentals (subject to deduction of any amounts due for unpaid rentals). If the value of the repossessed asset is less than the amount to be refunded (before any such deduction), the difference constitutes a loss to the lessor. This exposes the Islamic bank licensee as lessor to a form of market risk¹⁵.

¹⁵ The contract should include clauses that cover the treatment of destruction or loss of the property without any fault of the tenant. The contract should also elaborate how the bank as a lessor will cover itself in the absence of any Takaful.

CA-3.5.10

In theory, a situation could arise in which, when an IMB contract arrives at its term, the lessee decides not to exercise its option to complete the purchase by making the contractually agreed final payment (The option to purchase places no obligation on the lessee to do so.). The Islamic bank licensee may thus be exposed to market risk, in respect of a potential loss from disposing of the asset for an amount lower than its residual value.

CA-3.5.11

In the case of IMB, the lessor's exposure in such a case described in Paragraph CA-3.5.10 would not be significant, as the option to purchase can be exercised by making a payment of a token amount and the lessee would have no reason to refrain from exercising it. Moreover, the residual value of the asset in the lessor's book at the term of a full payout of the IMB (i.e. its residual value as assumed in fixing the lease rentals) would be zero or close to zero.

CA-3.5.12

In a binding PL, when an Islamic bank licensee is exposed to default on the lease orderer's obligation to execute the lease contract, the exposure is measured as the amount of the asset's total acquisition cost to the Islamic bank licensee, less the market value of the asset where it is eligible collateral subject to any haircut (see Paragraph CA-4.7.25), and less the amount of any urbun received from the lease orderer. The applicable RW must be based on the standing of the obligor as rated by an ECAI that is approved by the CBB (refer to section CA-4.6), and in the case the obligor is unrated, a RW of 100% applies. The Islamic bank licensee may or may not have the right to recoup from the customer any loss on leasing or disposing of the asset after taking account of the HJ, depending on the terms of the contract.

CA-3.5.13

In applying the treatment as set out in Paragraph CA-3.5.12, the Islamic bank licensee must ensure that the PL is properly documented and is legally enforceable. In the absence of proper documentation and legal enforceability, the asset is to be treated similarly to one in a non-binding PL which is exposed to market (price) risk, using the measurement approach as set out in Subparagraph CA-3.5.18(a).

CA-3.5.14

In addition to the credit risk mentioned in Paragraph CA-3.5.12, when the lessee gets the right to use the asset, the lessor is exposed to credit risk for the estimated value of the lease payments in respect of the remaining period of the Ijarah. This exposure is mitigated by the market value of the leased asset where it is eligible collateral (subject to the applicable haircut) if it can be repossessed. The net credit risk exposure is assigned a RW based on the credit standing of the lessee/counterparty as rated by an ECAI that is approved by the CBB. In the case that the lessee is unrated, a RW of 100% applies. See Paragraph CA-4.7.25 for eligible collateral.

CA-3.5.15

In addition to credit risk mentioned in Paragraphs CA-3.5.12 and CA-3.5.13, the capital requirement for IMB is based on the following two components:

CA-3.5.16

The capital requirement must be calculated on the receivable amount, net of:

CA-3.5.17

In the case of an asset acquired and held for the purpose of either operating Ijara or IMB, the capital charge to cater for market (price) risk in respect of the leased asset from its acquisition date until its disposal can be categorised as follows:

¹⁶ In the case of HJ, the amount can only be deducted for damages — that is, the difference between the asset acquisition cost and the total of lease rentals (when the asset is leased to a third party) or selling price (when the asset is sold to a third party), whichever is applicable.

CA-3.5.18

In case CA-3.5.17(b)(i), if the down-payment was made as HJ, the Islamic bank licensee has the right to recoup any loss (as indicated in the previous paragraph) from the customer; that right constitutes a claim receivable which is exposed to credit risk, and the exposure must be measured as the amount of the asset's total acquisition cost to the Islamic bank licensee, less the market value of the asset if it may be repossessed and where it is eligible collateral (see Paragraph CA-4.7.25) subject to any haircut, and less the amount of any HJ. The applicable RW must be based on the standing of the customer as rated by an ECAI that is approved by the CBB. In cases where the obligor is unrated, a RW of 100% applies.

CA-3.5.19

In case CA-3.5.17(b)(ii), the Islamic bank licensee has no right to recoup any losses, and the cost of the asset to the Islamic bank licensee constitutes a market risk (as in the case on a non-binding PL), but this market risk exposure is reduced by the amount of any HJ that the Islamic bank licensee has the right to retain.

CA-3.5.20

The residual value of the asset is risk-weighted at 100%. Upon expiry of the lease contract, the carrying value of the leased asset must carry a capital charge of 15% until the asset is re-leased or disposed of.

CA-3.5.21

In the event that the lessee exercises its right to cancel the lease, the lessor is exposed to the residual value of the leased asset being less than the refund of payments due to the lessee. In such a case, the price risk, if any, is already reflected in a 'haircut' to be applied to the value of the leased asset as collateral in credit risk. Therefore, the price risk, if any, is not applicable in the context of the IMB.

CA-3.5.22

The following tables set out the applicable stage of the contract that attracts capital charges:

Operating Ijara

* This credit RW is applicable only when the bank has recourse to any HJ paid by the customer, and (depending on the legal situation) may have a right to recoup from the customer any loss on leasing or disposing of the asset to a third party, after taking account of the HJ. If the bank has no such right, the cost of the asset to the bank constitutes a market risk (as in the case of a non-binding PL), but this market risk exposure is reduced by the amount of any HJ that the bank has the right to retain.

CA-3.5.23

IMB

* This credit RW is applicable only when the bank has recourse to any HJ paid by the customer. In the case of HJ (depending on the legal situation), the bank may have a right to recoup from the customer any loss on leasing or disposing of the asset to a third party, after taking account of the HJ, while any excess HJ must be refunded. If the bank has no such right, the cost of the asset to the bank constitutes a market risk (as in the case of a non-binding PL), but this market risk exposure is reduced by the amount of any HJ that the bank has the right to retain.