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  • CA-3.7 CA-3.7 Mudarabah

    • Introduction

      • CA-3.7.1

        This Section sets out the minimum capital adequacy requirement to cover the risk of losing invested capital arising from entering into contracts or transactions that are based on the Shari'a rules and principles of Mudarabah where the Islamic bank licensee assumes the role of capital provider ('rab al mal'). This Section is applicable to both restricted and unrestricted Mudarabah financing.

        January 2015

      • CA-3.7.2

        A Mudarabah is an agreement between the Islamic bank licensee and a customer whereby the Islamic bank licensee would contribute capital to an enterprise or activity which is to be managed by the customer as the (labour provider or) Mudarib.

        January 2015

      • CA-3.7.3

        Profits generated by that enterprise or activity are shared in accordance with the terms of the Mudarabah agreement whilst losses are to be borne solely by the Islamic bank licensee unless the losses are due to the Mudarib's misconduct, negligence or breach of contracted terms.

        January 2015

      • CA-3.7.4

        A Mudarabah financing can be carried out on either:

        (a) A restricted basis, where the capital provider allows the Mudarib to make investments subject to specified investment criteria or certain restrictions such as types of instrument, sector or country exposures, etc.; or
        (b) An unrestricted basis, where the capital provider allows the Mudarib to invest funds freely based on the latter's skills and expertise.
        January 2015

      • CA-3.7.5

        As the capital provider, the Islamic bank licensee is exposed to the risk of losing its capital investment ('capital impairment risk') upon making payment of the capital to the Mudarib. Any loss on the investment is to be borne solely by the capital provider, but is limited to the amount of his capital. Losses that are due to misconduct, negligence or breach of contractual terms, are to be borne by the Mudarib.

        January 2015

      • CA-3.7.6

        While it is not permissible for a Mudarib to give a guarantee against losses outlined in Paragraph CA-3.7.5, a guarantee may be given by a third party on the basis of tabarru (donation). In such a case, the amount of the Mudarabah capital so guaranteed may be considered as subject to credit risk with a risk weighting equal to that of the guarantor.

        January 2015

      • CA-3.7.7

        Guarantees referred to in Paragraph CA-3.7.6 may be given when liquid funds are placed in an Islamic interbank market under a Mudarabah contract.

        January 2015

    • Equity Position Risk

      • CA-3.7.8

        Apart from placements identified in Paragraph CA-3.7.7, Mudarabah contracts are commonly used for the investment purposes mentioned in Paragraph CA-3.7.10.

        January 2015

      • CA-3.7.9

        In assigning the RW, consideration is given to the intent of the Mudarabah investment, and to the nature of the underlying assets. The intent may be:

        (a) The purchase of assets for trading;
        (b) Investing on an equity basis in an ongoing business venture with the intention of holding the investment for an indefinite period, perhaps with a view to eventual sale (e.g. venture capital investments); or
        (c) Project finance. The underlying assets may be tradable assets such as commodities, foreign exchange or securities, or business assets such as real property, plant and equipment, and working capital. Real property and movable property may also be purchased with a view to generating rental income by means of Ijara contracts.
        January 2015

      • CA-3.7.10

        For the purpose of calculating the minimum capital requirement, Islamic bank licensees must make distinctions between the three main categories of Mudarabah, as set out in Paragraphs CA-3.7.11 to 3.7.13.

        January 2015

    • Private Commercial Enterprise to Undertake Trading Activities in Foreign Exchange, Shares or Commodities.

      • CA-3.7.11

        This type of Mudarabah exposes the Islamic bank licensee to the risk of the underlying activities, namely foreign exchange, equity or commodities.

        January 2015

    • Private Commercial Enterprise to Undertake a Business Venture (other than outlined in Paragraph CA-3.7.11.)

      • CA-3.7.12

        This type of Mudarabah exposes the Islamic bank licensee to risk as an equity holder, which is similar to the risk assumed by a partner in venture capital or a joint venture, but not to market risk. As an equity investor, the Islamic bank licensee serves as the first loss position and its rights and entitlements are subordinated to the claims of secured and unsecured creditors. For further explanation of the nature of risk in such ventures, see Paragraphs CA-4.8.4 to CA-4.8.6.

        January 2015

    • Mudarabah Investments in Project Finance

      • CA-3.7.13

        An Islamic bank licensee advances funds to a customer who acts as Mudarib in a construction contract for a third-party customer (ultimate customer). The ultimate customer will make progress payments to the Mudarib who, in turn, makes payments to the Islamic bank licensee. The essential role of the Islamic bank licensee in this structure is to provide bridging finance to the Mudarib pending its receipt of the progress payments. In this type of construction contract Mudarabah investment structure:

        (a) The Islamic bank licensee has no direct or contractual relationship with the ultimate customer (but the Islamic bank licensee may stipulate that payments by the ultimate customer to the Mudarib be made to an account ("repayment account") with the Islamic bank licensee which has been opened for the purpose of the Mudarabah and from which the Mudarib may not make withdrawals without the Islamic bank licensee's permission); and
        (b) The Islamic bank licensee as investor advances funds to the construction company as Mudarib for the construction project and is entitled to a share of the profit of the project but must bear 100% of any loss.
        January 2015

      • CA-3.7.14

        The Islamic bank licensee is exposed to the risk on the amounts paid to the Mudarib, and as these amounts are made on a profit-sharing and loss-bearing basis they are treated under credit risk as equity positions in the banking book. In principle, the Islamic bank licensee's credit exposure is to the Mudarib, not to the ultimate customer; however, as described below, a structure may involve the use of a "repayment account" to receive progress payments from the ultimate customer, which transfers much of the credit risk to the latter.

        January 2015

      • CA-3.7.15

        In addition to credit risk (i.e. that the Mudarib has received payment from the ultimate customer but fails to pay the Islamic bank licensee, or that the ultimate customer fails to pay), the Islamic bank licensee is exposed to capital impairment in case the project results in a loss.

        January 2015

    • Direct Payment by Ultimate Customer into a "Repayment Account" Opened with the Bank and Effectively Pledged to the Bank

      • CA-3.7.16

        Much of the Islamic bank licensee's credit exposure to the Mudarib may be transferred to the ultimate customer under this structure involving the "repayment account". If the ultimate customer is a sovereign or otherwise has a very low risk-weighting, this may affect the RW to be applied to the exposure, and other credit risk mitigants may be applied, as described below.

        January 2015

      • CA-3.7.17

        In a construction related transaction, provided the construction work proceeds normally and to the ultimate customer's satisfaction, the risk attaching to the progress payments due from the ultimate customer to the Mudarib will be the credit risk of the ultimate customer. However, this does not per se constitute a mitigation of the credit risk of the Islamic bank licensee's exposure to the Mudarib. In such a case, if an independent engineer employed to certify that the work has reached a certain stage of completion has issued a certificate to that effect, so that a progress payment is due from the ultimate customer, from the point of view of the Islamic bank licensee the amount of that progress payment due is no longer exposed to the risk of unsatisfactory performance by the Mudarib, but only to the latter's failure to pay the Islamic bank licensee (the Mudarib being exposed to possible default by the ultimate customer). Such an amount might thus arguably bear a RW based entirely on the credit standing of the Mudarib — that is, say 100%, rather than 400%. However, if a binding agreement exists between the Islamic bank licensee and the ultimate customer whereby the latter will make the payment into a "repayment account" with the Islamic bank licensee, the latter's credit exposure in respect of the amount due is transferred from the Mudarib to the ultimate customer.

        January 2015

      • CA-3.7.18

        Other structures may be used which have the effect of modifying the risk exposures of the investors in a Mudarabah. The determination of the risk exposure (nature and amount) must take into account the structure which must be reflected in the application of RW.

        January 2015

    • Equity Position Risk

      • CA-3.7.19

        The equity exposure must be measured based on the nature of the underlying investments:

        (a) For investments held in the trading book, the exposure is equal to the fair value; or
        (b) For investments held to maturity, the exposure is equal to the carrying value — that is, either the fair value or the historical cost less any provisions for impairment.
        January 2015

      • CA-3.7.20

        The Mudarabah exposures, must be measured net of specific provisions.

        January 2015

    • Private Commercial Enterprise to Undertake Trading Activities in Foreign Exchange, Shares or Commodities

      • CA-3.7.21

        The RW must be based on the applicable underlying assets as set out in the market risk section in Chapter CA-5. An investment in foreign exchange and trading in gold/silver must be measured according to the treatment set out in Section CA-5.5, which requires an 8% capital charge on the greater of either net long or net short positions and an 8% capital charge on the net position of gold/silver.

        The RW of a Mudarabah that invests in quoted shares must be measured according to the equity position risk approach where positions in assets tradable in markets qualifies for treatment as equity position risk in the trading book, which incurs a total capital charge of 16% (equivalent to 200% RW) as set out in Section CA-5.3.

        Investment in commodities must be measured according to either the maturity ladder approach or the simplified approach, as set out in Section CA-5.6.

        January 2015

    • Private Commercial Enterprise to Undertake a Business Venture (other than Paragraph CA-3.7.21)

      • CA-3.7.22

        There are two possible methods used to calculate the equity exposures in this type of investment — that is:

        a) The simple risk-weight method; and
        (b) The slotting method.

        The calculation details are set out in Paragraphs CA-4.8.7 to 4.8.11.

        January 2015

    • Mudarabah Investment in Project Finance

      • CA-3.7.23

        The Islamic bank licensee's overall credit exposure in respect of the Mudarabah in such a case is divided into three parts:

        (a) The amount receivable by the Islamic bank licensee from the Mudarib in respect of progress payments due to the Mudarib from the ultimate customer for work certified as having reached a certain stage of completion: If a binding agreement exists as described in Paragraph CA-3.7.13, whereby the amount will be paid by the ultimate customer into a "repayment account" with the Islamic bank licensee, the RW reflects the credit standing of the ultimate customer. In the absence of such an agreement, the RW reflects the credit standing of the Mudarib (or 100% RW for unrated customer);
        (b) The amount held in the "repayment account" with the Islamic bank licensee, which has a risk weighting of 0%; and
        (c) For any remaining balance of the funds advanced by the Islamic bank licensee to the Mudarib, which incurs a RW of between 300% and 400% under the simple RW method, or between 90% and 270% under the slotting method, unless otherwise rated, the treatment as set out in Paragraph CA-3.7.12 applies.
        January 2015

    • Summary of Capital Requirements for Mudarabah Categories

      • CA-3.7.24

        The Mudarabah categories that attract capital charges of Paragraphs CA-3.7.11 and CA-3.7.12 are:

        Mudarabah Category Credit RW Market Risk Capital Charge
        Private commercial enterprise to undertake trading activities in the foreign exchange, share and/or commodity Not applicable Depends on the underlying asset as set out in the applicable market risk section
        Private commercial enterprise to undertake business venture other than trading activities in the foreign exchange, share and/or commodity
        (a) Simple risk-weight method: 400% RW* of the contributed amount to the business venture less any specific provisions or:
        (b) Slotting method: Between 90% and 270% RW of the contributed amount to the business venture based on the four categories
        		 Not applicable

        * 300% RW may be applied if the funds are subject to withdrawal by the investor at short notice.

        January 2015

      • CA-3.7.25

        The applicable stages in a Mudarabah contract in project finance that attract capital charges of Paragraph CA-3.7.13 are:

        Applicable Stages in a Contract Credit RW Market Risk Capital Charge
        Prior to certification, where funds are already advanced by the bank to the Mudarib Risk weight is based on the rating of either the ultimate customer or the Mudarib (see Paragraph CA-3.7.13). Otherwise, 400% RW is applied to an unrated Mudarib. Not applicable
        After certification, where the amount is receivable by the bank from the Mudarib in respect of progress payment to the Mudarib from the ultimate customer If a "repayment account" or similar mitigation structure is used, RW is based on the credit standing of the ultimate customer on the amounts receivable by the bank from the Mudarib (or 100% RW for unrated customer). Not applicable
        January 2015