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.