CA-3.2.1

This section sets out the minimum capital adequacy requirements to cover the transactions that are based on the Sharia rules and principles of Murabaha and Murabaha to the Purchase Orderer (MPO).

CA-3.2.2

In Murabaha and MPO, the capital requirement for credit risk refers to the risk of a counterparty not paying the purchase price of an asset to the Islamic bank licensee. In the case of market (price) risk, the capital requirement is applicable with respect to: (a) assets in the Islamic bank licensee's possession which are available for sale either on the basis of Murabaha or MPO; and (b) assets which are in its possession due to the customer's non-performance of a promise to purchase (PP) in either non-binding or binding MPO.

CA-3.2.2A

The CBB has discretion to apply to Islamic bank licensee the relevant provisions of this section for other forms of sale contract, namely Musawamah and Bay` Bithaman Ajil.

CA-3.2.3

This section is broadly divided into (a) Murabahah and non-binding MPO and (b) binding MPO, as the types of risk faced by the Islamic bank licensee are different at the various stages of the contract for the two categories.

CA-3.2.4

This classification and the distinctions between a non-binding MPO and a binding MPO are subject to the criteria and opinions set by the respective SSB of the Islamic bank licensee.

CA-3.2.5

A Murabahah contract refers to an agreement whereby the Islamic bank licensee sells to a customer at acquisition cost (purchase price plus other direct costs) plus an agreed profit margin, a specified kind of asset that is already in its possession. An MPO contract refers to an agreement whereby the Islamic bank licensee sells to a customer at cost (as above) plus an agreed profit margin, a specified kind of asset that has been purchased and acquired by the Islamic bank licensee based on a Promise to Purchase (PP) by the customer which can be a binding or non-binding PP.

CA-3.2.6

In a Murabahah transaction, the Islamic bank licensee sells an asset that is already available in its possession, whereas in a MPO transaction the Islamic bank licensee acquires an asset in anticipation that the asset will be purchased by the orderer/customer.

CA-3.2.7

The price risk in Murabahah contracts ceases and is replaced by credit risk for the amount receivable from the customer following delivery of the asset. Likewise, in a non-binding MPO transaction, the Islamic bank licensee is exposed to credit risk on the amount receivable from the customer when the latter accepts delivery and assumes ownership of the asset.

CA-3.2.8

In a binding MPO, the Islamic bank licensee has no "long" position in the asset that is the subject of the transaction, as there is a binding obligation on the customer to take delivery of the asset at a pre-determined price. The Islamic bank licensee is exposed to counterparty risk in the event that the orderer in a binding MPO does not honour his/her obligations under the PP, resulting in the Islamic bank licensee having to dispose of the asset to a third party at a selling price which may be lower than the cost to the Islamic bank licensee. Depending on the Shari'a rulings that are applicable, the risk of selling at a loss may be mitigated by requiring the customer to deposit a Hamish Jiddiyah (HJ) upon executing the PP, as commonly practised in the case of a binding MPO. The Islamic bank licensee would have recourse to the customer for any shortfall in the HJ to compensate for the loss, and would be obliged to refund to the customer any amount of the HJ in excess of the loss. The HJ may be treated, after the conclusion of Murabahah, as part of the payment of the agreed selling price under the Murabahah contract. Alternatively, the Islamic bank licensee may take a down-payment (Urbun) from the purchase orderer when signing the contract. This payment is retained by the Islamic bank licensee if the purchase orderer fails to execute the contract, whereas on the execution of the contract the Urbun is treated as a payment in advance.

CA-3.2.9

The Islamic bank licensee can secure a pledge of the sold asset/underlying asset or another tangible asset ("collateralised Murabahah"). The collateralisation is not automatically provided in a Murabahah contract but must be explicitly stated or must be documented in a separate security agreement at or before the time of signing of the Murabahah contract. The Islamic bank licensee may employ other techniques such as pledge of deposits or a third party financial guarantee. The Risk Weight (RW) of a financial guarantor can be substituted for the RW of the purchaser provided that the guarantor has a better credit rating than the purchaser and that the guarantee is legally enforceable (see Section CA-4.7).

CA-3.2.10

In financing transactions that are collateralised, the CRM would take into account of any 'haircut' applicable to the any eligible financial collateral listed in Paragraph CA-4.7.25). Murabahah and binding MPO collateralised by real estate is covered in Paragraphs CA-4.2.19–20.

Murabahah and Non-binding MPO

CA-3.2.13

In a binding MPO, the Islamic bank licensee is exposed to default on the purchase orderer's obligation to pay fully for the asset at the agreed price. In the event of the orderer defaulting on its PP, the Islamic bank licensee will dispose of the asset to a third party. The Islamic bank licensee will have recourse to any HJ⁹ paid by the orderer, and (a) may have a right to recoup from the orderer any loss on disposing of the asset, after taking account of the HJ or (b) may have no such legal rights. In both cases, this risk is mitigated by the asset in possession as well as any HJ paid by the purchase orderer.

⁹ The bank's recourse to HJ should be within the limits of the actual loss, which is the difference between the actual cost and the sale price of the asset.

CA-3.2.14

In case (a) of Paragraph CA-3.2.13, the Islamic bank licensee has the right to recoup any loss (as indicated in the previous paragraph) from the orderer, that right constitutes a claim receivable which is exposed to credit risk, and the exposure shall be measured as the amount of the asset's total acquisition cost to the Islamic bank licensee, (less the value of any eligible financial 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 obligor as rated by an ECAI that is approved by the CBB, and in the case the obligor is unrated, a RW of 100% shall apply (See Section CA-4.2).

CA-3.2.15

In case (b) of Paragraph CA-3.2.13, the Islamic bank licensee has no legal right, and the cost of the asset to the Islamic bank licensee constitutes a market risk (as in the case on a non-binding MPO), but the market risk exposure is reduced by the amount of any HJ that the Islamic bank licensee has the right to retain.

CA-3.2.16

In applying the treatment as set out in the Paragraph CA-3.2.15, the Islamic bank licensee must ensure that the PP is properly documented and legally enforceable. In the absence of proper documentation and legal enforceability, the asset is to be treated as similar to a non-binding MPO which is exposed to price risk, where the measurement approach is as set out in Paragraphs CA-3.2.20 and CA-3.2.21.

CA-3.2.17

Upon selling the asset, the accounts receivable (net of specific provisions) amount must be assigned a RW based on the credit standing of the obligor as rated by an ECAI that is approved by the CBB. In case the obligor is unrated, a RW of 100% applies. (See Section CA-4.2).

CA-3.2.18

The capital requirement is to be calculated on the receivable amount, net of (i) specific provisions, (ii) any amount that is secured by eligible financial collateral (as defined in Paragraph CA-4.7.25) and/or (iii) any amount that is past due 90 days or more (see Section CA-4.2).

CA-3.2.19

The assets of collateralised Murabaha may be categorised as per the claim categories detailed in Section CA-4.2, and risk weighted accordingly. Islamic bank licensees should ensure that the appropriate risk weight is used based on the claim category for each transaction.

Murabahah and Non-binding MPO

CA-3.2.22

In a binding MPO the orderer has the obligation to purchase the asset at the agreed price, and the Islamic bank licensee as the seller is not exposed to market risk in respect of the asset, but only to credit risk as indicated in Paragraph CA-3.2.13.

CA-3.2.23

If the funding of an asset purchase or the selling of an asset opens an Islamic bank licensee to foreign exchange exposures, the relevant positions must be included in the measurement of foreign exchange risk described in Section CA-5.5.

CA-3.2.24

The following table sets out the applicable stages of the contract that attracts capital charges:

CA-3.3.1

This section sets out the minimum capital requirement to cover credit and market (price) risks arising from entering into contracts or transactions that are based on the Shari'a rules and principles of Salam. The Islamic bank licensee is exposed to the (a) credit (counterparty) risk of not receiving the purchased commodity after disbursing the purchase price to the seller, and (b) price risk that the Islamic bank licensee incurs from the date of execution of a Salam contract, which is applicable throughout the period of the contract and beyond the maturity date of the contract as long as the commodity remains on the balance sheet of the Islamic bank licensee, in the absence of a hedge in the form of a parallel Salam contract covering the subject matter (A parallel contract may also be used to hedge part of the exposure).

CA-3.3.2

This section is applicable to (a) Salam contracts that are executed without any Parallel Salam contracts and (b) Salam contracts that are backed by independently executed Parallel Salam contracts.

CA-3.3.3

A Salam contract refers to an agreement to purchase, at a predetermined price, a specified kind of commodity¹⁰ which is to be delivered on a specified future date in a specified quantity and quality. The Islamic bank licensee as the buyer makes full payment of the purchase price upon execution of a Salam contract or within a subsequent period not exceeding two or three days as deemed permissible by its Sharia Supervisory Board (SSB).

¹⁰ A commodity is defined as a physical product which is and can be traded on a secondary market, e.g. agricultural products, minerals (including oil) and precious metals. The commodity may or may not be traded on an organised exchange.

CA-3.3.4

In certain cases the Islamic bank licensee may enter into a back-to-back contract (Parallel Salam) to sell a commodity with the same specification as the purchased commodity under a Salam contract to a party other than the original seller. The Parallel Salam allows the Islamic bank licensee to sell the commodity for future delivery at a predetermined price (thus hedging the price risk on the original Salam contract) and protects the Islamic bank licensee from having to take delivery of the commodity and warehousing it. As noted above, such a parallel contract may also be used as a partial hedge.

CA-3.3.5

The non-delivery of the commodity by a Salam seller (i.e. counterparty risk) does not discharge the Islamic bank licensee's obligations to deliver the commodity under a Parallel Salam contract, and thus exposes the Islamic bank licensee to potential loss in obtaining the supply elsewhere.

CA-3.3.6

The obligations of an Islamic bank licensee under Salam and Parallel Salam are not inter-conditional or interdependent, which implies that there is no legal basis for offsetting credit exposures between the contracts.

CA-3.3.7

In the absence of a Parallel Salam contract, an Islamic bank licensee may sell the subject-matter of the original Salam contract in the spot market upon receipt, or, alternatively, the Islamic bank licensee may hold the commodity in anticipation of selling it at a higher price. In the latter case, the Islamic bank licensee is exposed to price risk on its position in the commodity until the latter is sold.

CA-3.3.8

The receivable amount generated from the purchase of a commodity based on a Salam contract must, in appropriate cases, be assigned a RW based on the credit standing of a supplier/counterparty as rated by an ECAI that is approved by the CBB. If the supplier/counterparty is unrated (which will normally be the case), a RW of 100% applies (See Section CA-4.2).

CA-3.3.9

The capital requirement is to be calculated on the receivable amount, net of specific provisions. Amounts that are secured by eligible collateral as defined are covered in Section CA-4.7 and amounts that are past due 90 days or more are covered in Paragraph CA-4.2.21.

CA-3.3.10

The credit RW will be applied from the date of the contract made between both parties until the maturity of the Salam contract, which is upon receipt of the purchased commodity. However, between the date of contract and disbursement of funds to the customer the exposure is a commitment (off-balance sheet) and a credit conversion factor (CCF) of 20% will be applied before applying the relevant RW.

CA-3.3.11

The credit exposure amount of a Salam contract is not to be offset against the exposure amount of a Parallel Salam contract, as an obligation under one contract does not discharge an obligation to perform under the other contract.

CA-3.3.12

The price risk on the commodity exposure in Salam is measured using either: (a) the maturity ladder approach; or (b) the simplified approach (see section CA-5.6). Under the simplified approach, the capital charge will be equal to 15% of the net position in each commodity, plus an additional charge equivalent to 3% of the gross positions, long plus short, to cover basis risk and forward gap risk. The 3% capital charge is also intended to cater for potential losses in parallel Salam when the seller in the original Salam contract fails to deliver and the Islamic bank licensee has to purchase an appropriate commodity in the spot market to honour its obligation.

CA-3.3.13

The long and short positions in a commodity, which are positions of Salam and Parallel Salam, may be offset under either approach for the purpose of calculating the net open positions provided that the positions are in the same group of commodities.

CA-3.3.14

If the funding of a commodity purchase or selling of a commodity leaves an Islamic bank licensee open to foreign exchange exposures, the relevant positions must be included in the measures of foreign exchange risk described in Section CA-5.5.

CA-3.3.15

The following table sets out the applicable stage of the contract that attracts capital charges:

CA-3.4.1

This Section sets out the minimum capital adequacy requirement to cover credit and market (price) risks arising from entering into contracts or transactions that are based on the Sharia rules and principles of Istisna'a.

CA-3.4.2

Istisna'a and parallel Istisna'a contracts would attract a risk weighting as per the credit standing of the respective counterparties (See Section CA-4.2).

CA-3.4.3

An Istisna'a contract refers to an agreement to sell to or buy from a customer, a non-existent asset which is to be manufactured or built according to the ultimate buyer's specifications and is to be delivered on a specified future date at a predetermined selling price.

CA-3.4.3A

In an Istisna'a contract, price and other necessary specifications must also be fixed and fully settled between the buyer and manufacturer/builder. The payments by the buyer in Istisna'a may be made in advance, during the period of construction reflecting stages of completion, or deferred to a specified future date. The contract of Istisna'a is a binding contract that cannot be cancelled unilaterally by either party once the manufacturing work starts. If the subject matter does not conform to the specification agreed upon, the buyer has the option to accept or to refuse the subject matter.

CA-3.4.3B

The subject matter on which transaction of Istisna'a is based is always an item which needs to be manufactured or constructed, such as a ship, an aircraft or a building, and it cannot be an existing and designated asset. Istisna'a may also be used for similar projects such as installation of an air-conditioner plant in the customer's factory, or building a bridge or a highway.

CA-3.4.3C

The price of an asset under this contract is agreed or determined on the contractual date, and such a contract is binding. The price cannot be increased or decreased on account of an increase or decrease in commodity prices or labour cost. The price can be changed subject to the mutual consent of the contracting parties, which is a matter for the commercial decision of the Islamic bank licensee and can result in a lower profit margin and a capital charge as outlined in Paragraph CA-3.4.24.

CA-3.4.4

In practice, an Islamic bank licensee can play different roles while engaging in the contract of Istisna'a, as follows:

¹¹ Where two such parallel Istisna'a contracts exist, it is customary to refer to one of the contracts as a "parallel Istisna'a". Typically, it is the contract which is entered into second which is referred to as the "parallel Istisna'a".

CA-3.4.5

This Section makes distinctions between two types of exposures in Istisna'a financing, as follows:

CA-3.4.6

In the Istisna'a contract, the Islamic bank licensee assumes the completion risk¹² that is associated with the failure to complete the project at all, delay in completion, cost overruns, occurrence of a force majeure event, and unavailability of qualified personnel and reliable seller(s) or sub-contractors, including any late completion penalty¹³ payable to the ultimate customer due to non-fulfilment of required specifications.

¹² In conventional project financing, the completion risk is normally borne by the project sponsor/contractor, and not by the bank, because the project sponsor/contractor has most often been asked to provide an undertaking to cover cost overruns.

¹³ Normally, the contract between the bank and the contractor will specify in a penalty clause the latter's liability for penalties in case of delays for which it is responsible.

CA-3.4.7

The exposures under Istisna'a involve credit and market risks, as described below. Credit exposures arise once the work is billed to the customer, while market (price) exposures arise on unbilled work-in-process (WIP).

CA-3.4.8

There is a capital requirement to cater for the credit (counterparty) risk of the Islamic bank licensee not receiving the selling price of the asset from the ultimate customer or contractor, either in pre-agreed stages of completion and/or upon full completion of the manufacturing or construction process. (The risk of a customer failing to complete such a transaction in project finance is referred to as "off-take risk" — see Appendix CA-5.)

CA-3.4.9

This Section also sets out the capital adequacy requirement to cater for the market risk that an Islamic bank licensee incurs from the date of manufacturing or construction, which is applicable throughout the period of the contract on unbilled WIP inventory.

CA-3.4.10

This Section is applicable to both (a) Istisna'a contracts that are executed without any parallel Istisna'a contracts, and (b) Istisna'a contracts that are backed by independently executed parallel Istisna'a contracts.

Istisna'a with Parallel Istisna'a

Credit Risk

Market Risk

Foreign Exchange Risk

Istisna'a with Parallel Istisna'a

Credit Risk

Market Risk

Foreign Exchange Risk

CA-3.4.38

The following tables set out the applicable period of the contract that attracts capital charges where the Islamic bank licensee is the seller.

CA-3.4.39

The following tables set out the applicable period of the contract that attracts capital charges where the Islamic bank licensee is acting as buyer.

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.

CA-3.6.1

This Section sets out the minimum capital adequacy requirement to cover the risk of loss on invested capital arising from entering into contracts or transactions that are based on the Sharia rules and principles of Musharakah and Diminishing Musharakah where the Islamic bank licensee and their customers/partner(s) contribute to the capital of the partnership and shares its profit or loss.

CA-3.6.2

This Section is applicable to both (a) Musharakah in which all the partners' share remains constant throughout the contract period; and (b) Diminishing Musharakah in which the share of the Islamic bank licensee is gradually reduced during the tenure of the contract until it is fully sold to the other partner(s).

CA-3.6.3

Musharakah contracts refer to partnerships in specific transactions or projects. These exclude participation in the share capital (equity) of other enterprises which is covered in Section CA-4.8.

CA-3.6.4

A Musharakah is an agreement between the Islamic bank licensee and a customer to contribute capital in various proportions to an enterprise, whether existing or new, or to ownership of a real estate or moveable asset, either on a permanent basis, or on a diminishing basis where the customer progressively buys out the share of the bank ("Diminishing Musharakah"). Profits generated by that enterprise or real estate/asset are shared in accordance with the terms of Musharakah agreement whilst losses are shared in proportion to the respective contributor's share of capital.

CA-3.6.5

An Islamic bank licensee may enter into a Musharakah contract with a customer as a means of providing a financing to the latter on a profit sharing and loss bearing basis. In this case, the Musharakah is normally of the diminishing type, in which the customer gradually purchases the Islamic bank licensee's partnership share over the life of the contract. This type of financing is one of the Sharia compliant alternatives to avoid a conventional term loan repayable by instalments, and as such it is exposed to credit risk for the customer's purchase payments as well as to the risk attached to the Islamic bank licensee's share of the underlying assets.

CA-3.6.6

This Section sets out the minimum capital adequacy requirement to cater for "capital impairment risk", the risk of losing the amount contributed to an enterprise or ownership of an asset. The Islamic bank licensee acts as a partner in a Musharakah contract and is exposed to the risk of losing its capital upon making payment of its share of capital in a Musharakah contract. A Musharakah can expose the Islamic bank licensee either to capital impairment risk or to 'credit risk', depending on the structure and purpose of the Musharakah and the types of asset in which the funds are invested. The invested capital is redeemable either by liquidation of the Musharakah assets at the end of the contract which has a fixed tenure or as mutually agreed by the partners, or upon divestment of partnership in an on-going Musharakah subject to giving a notice to other partners. The amount of capital redemption is represented by the value of a share of capital, which is dependent on the quality of the underlying investments or assets, and ability to generate profits and cash flows from the Musharakah.

CA-3.6.7

As a partner to a Musharakah contract, the Islamic bank licensee is not entitled to a fixed rate of return and is thus exposed to variable profits generated by the partnership which are shared on a basis as agreed in the Musharakah contract, whereas losses are to be borne by the Islamic bank licensee and its partners according to their respective ratio of invested capital. Therefore, the Islamic bank licensee is exposed to entrepreneurial risk of an active partner that manages the partnership and business risks associated with the underlying activities and types of investments or assets of the partnership.

CA-3.6.7A

For the purpose of determining the minimum capital adequacy requirement, this Section makes distinctions between the four main categories of Musharakah as set out below:

CA-3.6.8

The Islamic bank licensee's position in a diminishing Musharakah is set out in Paragraphs CA-4.8.12 to CA-4.8.15.

CA-3.6.9

For Musharakah, the equity exposure is measured based on the nature of the underlying investments as follows:

CA-3.6.10

For private commercial enterprises undertaking trading activities in foreign exchange, shares or commodities, the Musharakah exposures, net of provisions is measured as follows:

CA-3.6.11

For private commercial enterprise undertaking a business venture other than in Paragraph CA-3.6.12), there are two possible methods used to calculate the equity exposures:

CA-3.6.12

Musharakah in Ijara contract:

Income-producing Musharakah through leasing to third parties by means of Ijara contracts exposes the capital contributor to the risk of that underlying Ijara contract — that is, counterparty risk mitigated by the value of leased assets. This Musharakah investment is assigned a RW based on the credit standing of the counterparty/lessee, as rated by an ECAI that is approved by the CBB, and a 100% RW on the residual value of an Ijara asset (operating lease). In cases where the counterparty is unrated, a RW of 100% applies. (Please refer to the treatment for Ijara as set out in Paragraph CA-3.5.22.)

CA-3.6.13

Musharakah in Murabahah contract:

Income-producing Musharakah through selling to third parties by means of Murabahah contracts exposes the capital contributor to the risk of that counterparty/buyer. This Musharakah investment is assigned a RW based on the credit standing of the counterparty /buyer, as rated by an ECAI that is approved by the CBB. In cases where the counterparty is unrated, a RW of 100% applies. (Please refer to the treatment for Murabahah as set out in Section CA-3.2.

CA-3.6.14

The equity exposure in a Diminishing Musharakah contract, where the Islamic bank licensee has provided funds for the working capital of the partnership and intends to transfer its full ownership in movable assets and working capital to the other partner over the life of the contract, is calculated based on the remaining balance of the amount invested (measured at historical cost including any share of undistributed profits) less any specific provision for impairment. The exposure must be risk weighted according to the nature of the underlying assets as set out in Paragraphs CA-3.6.11 to CA-3.6.14. If a third party guarantee exists, to make good impairment losses, the RW of the guarantor is substituted for that of the assets (if lower) for the amount of any such guarantee. The Islamic bank licensee can use the risk weights under the slotting method (see Paragraph CA-3.6.11) after the required CBB approval, based on the criteria set out in Appendix CA-6.

CA-3.6.15

The following table sets out the Musharakah categories that attract capital charges:

^* In the case of Diminishing Musharakah, the contributed amount is based on the remaining balance of the invested amount.

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.

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.

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.

CA-3.7.4

A Mudarabah financing can be carried out on either:

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.

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.

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.

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.

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:

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.

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.

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.

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:

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.

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.

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.

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.

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.

CA-3.7.19

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

CA-3.7.20

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

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.

CA-3.7.22

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

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

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:

CA-3.7.24

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

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

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:

CA-3.9.1

This Section sets out the minimum capital requirement to cover the risk of losing capital arising from entering into contracts or transactions that are based on the Shari'a rules and principles of Qard.

CA-3.9.2

Qard is a loan given by an Islamic bank licensee, where the borrower is contractually obliged to repay only the principal amount borrowed.¹⁷ In the contract of Qard, no payment in addition to the principal amount lent may be required, as that would be a form of Riba.

¹⁷ As a business entity, banks provide financing to their customers to perform their role as financial intermediary and seek an opportunity to earn profits for their enterprise and for distribution to their shareholders and fund providers. Therefore, most banks will not be providing any significant amount of lending on the basis of Qard, as Shari'a rules and principles require the borrower to pay only the principal amount in that case. Nonetheless, a bank survey has shown that, in several jurisdictions, some banks do provide Qard-based lending for different reasons. These vary widely among banks and may include: (a) lending to some specific type of clients such as the poor, needy or widows, etc. as a part of Corporate Social Responsibility practice; (b) lending out of their Charity Account (built out of their non-permissible income) to small entrepreneurs and new businesses that do not have access to sufficient assets that can be used as collateral; (c) lending as a part of their business product — that is, not out of the Charity Account; (d) providing funding to various microfinance institutions or customers; and (e) lending mainly for marketing or public acceptance purposes, where a small portion of the overall financing portfolio is allocated to support certain activities of underprivileged sections of the population, etc.

CA-3.9.3

If a fixed period of repayment is stipulated in the contract, the borrower is liable to pay back the principal amount to the Islamic bank licensee on or before the agreed date of payment. On the other hand, if no period is stipulated in the contract, it is binding upon the borrower to make a repayment of the loaned amount to the lender on demand.

CA-3.9.4

As one of the CRM techniques, Islamic bank licensees can secure a pledge of a tangible asset. The collateralisation is not automatically provided in a Qard contract but must be explicitly stated or must be documented in a separate security agreement at or before the time of signing of the Qard contract. The Islamic bank licensee may employ other techniques such as pledge of deposits/PSIA or a third-party financial guarantee.

CA-3.9.5

Islamic bank licensees are exposed to credit risk in the event that the borrower fails to repay the principal amount in accordance with the agreed terms of the contract. In a fixed-period Qard contract, credit risk exposure commences upon the execution of the contract until the full repayment by the borrower.

CA-3.9.6

The credit exposure is measured based on account receivable in Qard — that is, the amount due from the customer at the end of the financial period less any provision for doubtful debts.

CA-3.9.7

The account receivable amount (net of specific provisions) arising from the Qard contract must be assigned a RW based on the credit standing of the borrower, as rated by an ECAI that is approved by the CBB (see Section CA-4.6). In cases where the borrower is unrated, a RW of 100% applies. The RW of a financial guarantor can be substituted for the RW of the borrower provided that the guarantor has a better credit rating than the borrower and that the guarantee is legally enforceable. If an exposure is covered by multiple CRM techniques, the exposure must be segregated into segments covered by each type of CRM technique as specified in Section CA-4.7. For any uncovered exposure, the RW of the underlying counterparty applies.

CA-3.9.8

In the case where a cash loan is provided by the Islamic bank licensee, there is no element of market risk. If, however, a loan is provided in a currency other than the local currency or in the form of a commodity, the related market risk is applicable, as outlined in Section CA-5.6.

CA-3.9.9

The following table sets out capital charges for lending on the basis of Qard:

^* Applicable only if Qard-based lending is made in the foreign currency or in commodities.

CA-3.10.1

This Section sets out the minimum capital adequacy requirement to cover the risk of losing invested capital arising from an Islamic bank licensee entering into asset-side financing contracts or transactions that are based on the Shari'a rules and principles of Wakalah.

CA-3.10.2

An Islamic bank licensee assumes the role of a principal (Muwakkil) and appoints the customer as agent (Wakil) to carry out a specified set of services or act on its behalf. This Section is applicable to both restricted and unrestricted Wakalah financing.

CA-3.10.3

Wakalah is a contract of agency whereby one person contracts to perform any work or provide any service on behalf of another person. Businesses rely on a range of individuals to act on their behalf; these include employees, directors, partners, and a range of professional agents. An action performed by an agent on behalf of the principal will be deemed to be an action by the principal. An agent will obtain fees for services rendered according to the contractual reward structure offered by the principal which may incorporate a performance-related element.

CA-3.10.4

Profits generated are distributed to the Muwakkil less the Wakil fee, in accordance with the terms of the Wakalah agreement. In case the contract includes some "indicative" or "expected" profit rate on the investment, the Wakalah contract can include a clause stipulating that the Wakil's remuneration may be:

CA-3.10.5

A Wakalah financing can be carried out on either:

CA-3.10.6

As the Muwakkil, the Islamic bank licensee is exposed to the risk of losing its invested capital — that is, capital impairment risk. Any loss on the investment is to be borne solely by the Muwakkil, but is limited to the amount of its capital. Losses that are due to fraud, misconduct, negligence or breach of contractual terms are to be borne by the Wakil. The Wakil shall be entitled to any pre-agreed flat Wakil fee irrespective of whether the actual profit is less than, equal to or greater than any expected profit, and also in the event of a loss.

CA-3.10.7

However, while it is not permissible for a Wakil to give a guarantee against losses or for any indicative or expected profits, such a guarantee may be given by a third party on the basis of tabarru' (donation). In such a case, the amount of the Wakalah capital so guaranteed may be considered as subject to credit risk with a risk-weighting equal to that of the guarantor. In particular, such guarantees may be given when liquid funds are placed in an Islamic interbank market under a Wakalah contract.

CA-3.10.8

In the absence of any fraud, misconduct, negligence or breach of contractual terms on the part of Wakil, all the risk of loss on the investment is to be borne by the Muwakkil. Therefore, the Islamic bank licensee is exposed to the skills of the Wakil that manages the investments on behalf of the Islamic bank licensee, as well as to business risks associated with the underlying activities and types of investments or assets of the Wakalah agreement.

CA-3.10.9

For the purpose of determining the minimum capital requirements, this section makes distinctions between the following main categories of Wakalah:

CA-3.10.10

The Wakalah exposures, are measured net of specific provisions as set out below.

CA-3.10.11

The RW is 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 or silver must be measured according to the treatment as 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.

CA-3.10.12

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

CA-3.10.13

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.

CA-3.10.14

If the Wakalah investment is to be utilised by the Wakil (another Islamic bank licensee) for conducting CMT to earn a (fixed rate of) profit, the investing Islamic bank licensee is primarily exposed to the counterparty risk. In that case, the invested amount (net of specific provisions) must be assigned a RW based on the credit standing of the counterparty as rated by an approved ECAI. In cases where the counterparty is unrated, a RW of 100% applies (see Section CA-4.2).

CA-3.10.15

This type of Wakalah investment exposes the Islamic bank licensee to capital impairment risk. Due to this downside risk, the RW is measured according to equity position in the banking book approach. The RW must be applied to the exposures net of specific provision, if any.

CA-3.10.16

As explained in Sections CA-3.6 and 3.7, there are two possible methods used to calculate the equity exposures, that is:

CA-3.10.17

The RW under the simple risk-weighting method (a) entails a RW of 300–400%. Under the slotting method (b), an Islamic bank licensee must map its RW into four supervisory categories as described in Appendix CA-5 (specialised financing) where the RWs of each category are as follows:

The above RWs under the slotting method for specialised financing include an additional fixed factor of 20% RW to cater for potential decline in the Wakalah net asset value.

For further explanation, also see Paragraphs CA-4.8.7 to 4.8.11.

CA-3.10.18

An Islamic bank licensee may place liquid funds with a central bank or another Islamic bank licensee on a Wakalah basis in order to obtain a return on those funds. Such placements are considered to be more secure than those identified in Paragraphs CA-3.10.11 to CA-3.10.14, owing to the available credit standing of, and the established relationship with, the counterparty in the interbank market.

CA-3.10.19

A placement of funds made by an Islamic bank licensee with another Islamic bank licensee under a Wakalah agreement (whether on a restricted or unrestricted basis) may be subject to a Shari'a-compliant guarantee from a third party. Such a guarantee can be related to the amount of principal invested, as well as the expected return. In such cases, the capital must be treated as subject to credit risk, with a risk weighting equal to that of the guarantor provided that the RW of that guarantor is lower than the RW of the Wakil as counterparty. Otherwise, the RW of the Wakil applies. As explained in Section CA-3.11 related to Mudarabah interbank placement, interbank placement received on a Wakalah basis can also be effectively treated as a liability by the Islamic bank licensee receiving the funds. In the absence of any guarantee mentioned earlier, the risk-weighting must be applied based on the credit standing of the counterparty as rated by an approved ECAI, or a RW of 100% for an unrated counterparty.

CA-3.10.20

If the funds placed under a Wakalah arrangement are placed in a foreign currency, in addition to the above treatment, capital charge related to foreign exchange risk is applicable as outlined in Section CA-5.5.

CA-3.10.21

The following table sets out the Wakalah categories that attract capital charges.

^* In the case of a third-party guarantee, the capital must be treated as subject to credit risk with a risk weighting equal to that of the guarantor provided that the RW of that guarantor is lower than the RW of the Wakil as counterparty. Otherwise, the RW of the Wakil applies.

^** If funds are invested in foreign exchange, foreign exchange risk will also be applicable as per Section CA-5.5.

CA-3.11.4

It is crucial for Islamic bank licensees to recognise and evaluate the overlapping nature and transformation of risks that exist between various types of risk. Since the dynamism of risk exposure through the phases of CMT is unique, Islamic bank licensees should break down the contractual timeline for CMT while managing the risks in each phase.

CA-3.11.5

An Islamic bank licensee may be exposed to market risk through any fluctuation in the price of the underlying commodity that comes into its possession for a longer duration than normal — for example, when a customer refuses to honour his commitment to buy or when the agreement is non-binding. With CMLF and CMF on the asset side, market risk transforms into credit risk; that is, market risk is applicable before selling the commodities to the counterparty, while upon their being sold to the counterparty on deferred payment terms the market risk converts into credit risk. In view of the market practice relating to CMT whereby the commodities are sold instantaneously after being bought on the basis of a binding promise, there would be no market risk. On the other hand, if an Islamic bank licensee holds title to the commodities for any length of time in the CMT transaction, a market risk exposure will be present. Placement of funds in currencies other than the local currency will also expose the Islamic bank licensee to foreign exchange risk.

CA-3.11.6

As in both CMLF and CMF, a binding promise from the customer exists to purchase the commodity; an Islamic bank licensee is exposed to default on the customer's obligation to purchase. In the event of default by the customer, the Islamic bank licensee disposes of the asset to a third party; that is, the credit risk is mitigated by the asset in possession as collateral, net of any haircut. The exposure must be measured as the amount of the total acquisition cost to the Islamic bank licensee for the purchase of commodities, less the market value of the commodities as collateral, subject to any haircut and specific provisions, if any. The RW of the counterparty must be applicable to the resultant receivables,²⁰ and would be based on credit ratings issued by a recognised ECAI.²¹ In the case of an unrated counterparty, the applicable RW will be 100%.

²⁰ In CMLF and CMF on the asset side, the bank is exposed to market risk in the interval before it sells the commodities to the counterparty, and subsequently to credit risk (accounts receivable risk), which is applicable after the bank sells those commodities to the counterparty.

²¹ If the credit exposure is funded and denominated in local currency and the counterparty is a domestic sovereign, a 0% risk weight shall be applied. Otherwise, a higher risk weight as suggested by the credit rating of the foreign sovereign is applicable.

CA-3.11.7

In applying the RWs outlined above, an Islamic bank licensee must ensure that the contracts for the transactions are properly documented and legally enforceable in a court of law. In the absence of these features, the commodities are exposed to market risk.

CA-3.11.8

In the presence of a binding promise to purchase from the counterparty (Paragraph CA-3.2.6) and legally enforceable contract documentation, no capital charge is applicable for market risk. Otherwise, a capital charge for commodities risk is applicable, and must be measured by using either the maturity ladder approach or the simplified approach as set out in Section CA-5.6.

CA-3.11.9

In case the exposure is denominated in a foreign currency, a capital charge on the foreign currency exposure must be calculated as outlined in Section CA-5.5.

CA-3.11.10

The following table delineates the applicable stage of the CMLF and CMF on the asset side and associated capital charges.

^* In the presence of a binding promise from the counterparty to purchase, and legally enforceable contract documentation, there will be no capital charge.