CA-4.2.1

Claims on governments of GCC member states (hereinafter referred to as GCC) and their central banks are normally risk weighted at 0%. Claims on other sovereigns and their central banks are given a preferential risk weighting of 0% where such claims are denominated and funded in the relevant domestic currency of that sovereign/central bank (e.g. if a Bahraini bank has a claim on government of Australia and the loan is denominated and funded in Australian dollar, it will be risk weighted at 0%). Such preferential risk weight for claims on GCC/other sovereigns and their central banks are allowed only if the relevant supervisor also allows 0% risk weighting to claims on its sovereign and central bank.

CA-4.2.2

Claims on sovereigns other than those referred to in Paragraph CA-4.2.1 must be assigned risk weights as follows:

CA-4.2.3

Claims on the Bank for International Settlements, the International Monetary Fund and the European Central Bank receive a 0% risk weight.

CA-4.2.4

Any claims on the Bahraini PSEs listed in Appendix CA-8 are treated as claims on the government of Bahrain and are eligible for 0% risk weighting.

CA-4.2.4A

In addition to the Bahraini PSEs listed in Appendix CA-8, existing exposures to the following entities which have been removed from the list of PSEs as of 1^st March 2016, will be grandfathered and will remain eligible for 0% risk weighting until the final maturity or sale of such exposure:

CA-4.2.4B

Any new claims to the entities listed under Paragraph CA-4.2.4A are subject to the normal risk weights as outlined in this Section.

CA-4.2.5

Where other supervisors also treat claims on named PSEs as claims on their sovereigns, claims to those PSEs are treated as claims on the respective sovereigns as outlined in Paragraphs CA-4.2.1 and CA-4.2.2. These PSEs must be shown on a list maintained by the concerned central bank or financial regulator. Where PSE's are not on such a list, they must be subject to the treatment outlined in Paragraph CA-4.2.6.

CA-4.2.6

Claims on all other (foreign) PSEs (i.e. not having sovereign treatment) denominated and funded in the home currency of the sovereign must be risk weighted as allowed by their home country supervisors, provided the sovereign carries rating BBB- or above. Claims on PSEs with no explicit home country weighting or to PSEs in countries of BB+ sovereign rating and below are subject to ECAI ratings as per the following table:

CA-4.2.7

Claims on commercial companies owned by governments must be risk weighted as normal commercial entities unless they are in the domestic currency and covered by a government guarantee in the domestic currency that satisfies the conditions in Section CA-4.7 in which case they may take the risk weight of the concerned government.

CA-4.2.8

MDBs currently eligible for a 0% risk weight are: the World Bank Group comprised of the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC), the Asian Development Bank (ADB), the African Development Bank (AfDB), the European Bank for Reconstruction and Development (EBRD), the Inter-American Development Bank (IADB), the European Investment Bank (EIB), the European Investment Fund (EIF), the Nordic Investment Bank (NIB), the Caribbean Development Bank (CDB), the Islamic Development Bank (IDB) and the Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), Arab Monetary Fund (AMF), the Council of Europe Development Bank (CEDB), the Arab Bank for Economic Development in Africa (ABEDA), Council of European Resettlement Fund (CERF) and the Kuwait Fund for Arab Economic Development (KFAED).

CA-4.2.9

The claims on MDBs, which do not qualify for the 0% risk weighting above, must be assigned risk weights as follows:

CA-4.2.10

Claims on banks must be risk weighted as given in the following table. No claim on an unrated bank may receive a risk weight lower than that applied to claims on its sovereign of incorporation (see guidance in Paragraph CA-4.2.11A for self-liquidating letters of credit).

CA-4.2.11

Short-term claims on locally incorporated banks must be assigned a risk weighting of 20% where such claims on the banks are of an original maturity of 3 months or less denominated and funded in either BD or US$. A preferential risk weight that is one category more favourable than the standard risk weighting must be assigned to claims on foreign banks licensed in Bahrain of an original maturity of 3 months or less denominated and funded in the relevant domestic currency (other than claims on banks that are rated below B-). Such preferential risk weight for short-term claims on banks licensed in other jurisdictions will be allowed only if the relevant supervisor also allows this preferential risk weighting to short-term claims on its banks.

CA-4.2.11A

Self-liquidating letters of credit issued or confirmed by an unrated bank are allowed a risk weighting of 20% without reference to the risk weight of the sovereign of incorporation. All other claims will be subject to the 'sovereign floor' of the country of incorporation of the concerned issuing or confirming bank. See also Paragraph CA-4.5.5.

CA-4.2.12

Claims with an (contractual) original maturity under 3 months that are expected to be rolled over (i.e. where the effective maturity is longer than 3 months) do not qualify for a preferential treatment for capital adequacy purposes.

CA-4.2.13

Claims on category one and category two investment firms which are licensed by the CBB are treated as claims on banks for risk weighting purposes but without the use of preferential risk weight for short-term claims. Claims on category three investment firms licensed by the CBB must be treated as claims on corporates for risk weighting purposes. Claims on investment firms in other jurisdictions will be treated as claims on corporates for risk weighting purposes. However, if the bank can demonstrate that the concerned investment firm is subject to an equivalent capital adequacy regime to this Module and is treated as a bank for risk weighting purposes by its home regulator, then claims on such investment firms must be treated as claims on banks.

CA-4.2.14

Risk weighting for corporates including insurance companies is as follows:

CA-4.2.15

Risk weighting for unrated (corporate) claims will not be given a preferential RW to the concerned sovereign. Credit facilities to small/medium enterprises may be placed in the regulatory retail portfolio in limited cases described below.

CA-4.2.16

The RW of a debtor, counterparty or other obligor is adjusted if the underlying assets are retail or real estate financed under Murabaha, Ijara, IMB, Istisna' or diminishing Musharakah, as set out in Paragraphs CA-4.2.17 to CA-4.2.20.

CA-4.2.17

Retail claims that are included in the regulatory retail portfolio must be risk weighted at 75%, except as provided in Paragraph CA-4.2.21 for the past due receivables.

CA-4.2.18

To be included in the regulatory retail portfolio, claims must meet the following criteria:

²³ Aggregated exposure means gross amount (i.e. not taking any credit risk mitigation into account) of all forms of debt exposures (e.g. finances or commitments) that individually satisfy the three other criteria. In addition, "to one counterpart" means one or several entities that may be considered as a single beneficiary (e.g. in the case of a small business that is affiliated to another small business, the limit would apply to the bank's aggregated exposure on both businesses).

CA-4.2.19

Financing facilities fully secured by first mortgages on RRE that is or will be occupied by the borrower, or that is leased, carry a risk weighting of 75%.

CA-4.2.19A

The RW for RRE may be reduced to 35% subject to meeting all of the criteria below:

CA-4.2.19B

The RW for residential mortgage exposure granted under the Social Housing Schemes of the Kingdom of Bahrain may be reduced to 25% subject to meeting conditions, (a) and (b) in CA-4.2.19A. The reduced risk weight is subject to ensuring the compliance with the requirements for timely recognition of expected credit loss (ECL) as per the Credit Risk Management Module (Module CM).

CA-4.2.20

Financing facilities secured by mortgages on commercial real estate are subject to a minimum of 100% risk weight but may be subject to higher risk weights depending on the financing structure (see CA-3). If the borrower is rated below BB-, the risk-weight corresponding to the rating must be applied.

CA-4.2.21

In the event that accounts receivable or lease payments receivable become past due, the exposure must be risk-weighted in accordance with the following table. The exposures should be risk weighted net of specific provisions (see Paragraph CA-4.3.5 for exposures risk-weighted under Supervisory Slotting Criteria).

CA-4.2.22

For the purposes of defining the secured portion of a past due receivable, eligible collateral and guarantees will be the same as for credit risk mitigation purposes.

CA-4.2.23

Past due retail receivables are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion, for risk-weighting purposes.

CA-4.2.24

Investments in listed equities below the thresholds mentioned in Chapter CA-2 must be risk weighted at 100% while unlisted equities must be risk weighted at 150% provided they are not subject to other treatments described in this paragraph and in CA-4.2.25–26 below. The amount of any significant investments in commercial entities above the 15% and 60% Total Capital materiality thresholds (see Paragraph CA-2.4.25) must be weighted at 800%. Significant investments in the common shares of unconsolidated financial institutions and Mortgage Servicing Rights and Deferred Tax Assets arising from temporary differences must be risk weighted at 250% if they have not already been deducted from CET1 as required by Paragraphs CA-2.4.15 to CA-2.4.24. For risk-weighting of Sukuk, refer to Chapter CA-8.

CA-4.2.25

Investments in funds (e.g. mutual funds, Collective Investment Undertakings etc.) must be risk weighted as follows:

CA-4.2.26

CBB may require an Islamic bank licensee to adopt the 'Simple Risk Weight Method' for equities (Section CA-4.4) if the CBB considers that Islamic bank licensee's equity portfolio is significant.

CA-4.2.26A

The amount of any large exposures exceeding the limits set in Chapter CM-4 must be weighted at 800%.

CA-4.2.27

See Chapter CA-9 for full details. All direct holdings of real estate by Islamic bank licensees (i.e. owned directly by the Islamic bank licensee on balance sheet) must be risk-weighted at 200%. Premises occupied by the Islamic bank licensee must be risk-weighted at 100%. Investments in Real Estate Companies (by way of investments in subsidiaries or associates or other arrangements such as trusts, funds or REITs) must be risk-weighted at 300% or 400% as outlined in Chapter 9 of this Module. Such equity investments will be subject to the materiality thresholds for commercial companies described in Paragraph CA-2.4.25 and therefore any holdings which amount to 15% or more of Total Capital will be subject to a 800% risk weight.

CA-4.2.28

Gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities must be treated as cash and therefore risk-weighted at 0%. In addition, cash items in the process of collection must be risk-weighted at 20%. The standard risk weight for all other assets will be 100%. Investments in regulatory capital instruments issued by banks or investment firms must be risk weighted at a minimum of 100%, unless they are deducted from the regulatory capital according to the corresponding deduction approach in Section CA-2.4 of this Module.

CA-4.2.29

Underwritings of capital instruments issued by other banking, financial or insurance entities are covered in Subparagraph CA-2.4.16(c) and CA-2.4.20(c). The large exposures limits of Chapter CM-4 apply for underwritings. This means the 800% risk weights apply for underwritings in excess of the limits set in Chapter CM-4. The risk weights below apply for exposures within the limits of Chapter CM-4. Where an Islamic bank licensee has acquired assets on its balance sheet in the banking book which it is intending to place with third parties under a formal arrangement, the following risk weightings apply for no more than 90 days. Once the underwriting period has expired, the usual risk weights must apply.

CA-4.2.30

Netting arrangements between financing assets and deposits will be permitted subject to the satisfaction of conditions in this Paragraph. The net exposure can be used for capital adequacy purposes if the Islamic bank licensee has a legally enforceable arrangement for netting or offsetting the financing assets and the deposits, irrespective of whether the counterparty is insolvent or bankrupt. The Islamic bank licensee must have a robust system of monitoring those financing assets and deposits with the counterparty that is subject to the netting arrangements. In using the net exposure for the calculation of capital adequacy, financing assets must be treated as exposures and deposits as collateral in the comprehensive approach (as per the formula provided in Paragraph CA-4.7.23). A zero haircut is applicable, except in the case of a currency mismatch.

CA-4.6.1

CBB will assess all External Credit Assessment Institutions (ECAI) according to the six criteria below. Any failings, in whole or in part, to satisfy these to the fullest extent will result in the respective ECAI's methodology and associated resultant rating not being accepted by the CBB:

CA-4.6.2

The CBB recognises Standard and Poor's, Moody's, Fitch IBCA, Capital Intelligence and the Islamic International Rating Agency as eligible ECAIs. With respect to the possible recognition of other rating agencies as eligible ECAIs, CBB will update this paragraph subject to the rating agencies satisfying the eligibility requirements. (See Appendix CA-7 for mapping of eligible ECAIs).

CA-4.6.3

Islamic bank licensees must use the chosen ECAIs and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. Islamic bank licensees will not be allowed to "cherry-pick" the assessments provided by different eligible ECAIs and to arbitrarily change the use of ECAIs.

CA-4.6.4

Islamic bank licensees must disclose in their annual reports the ECAIs that they use for the risk weighting of their assets by type of claims, the risk weights associated with the particular rating grades as determined by the CBB through the mapping process as well as the aggregated risk-weighted assets for each risk weight based on the assessments of each eligible ECAI.

CA-4.6.5

If there are two assessments by eligible ECAIs chosen by an Islamic bank licensee which map into different risk weights, the higher risk weight must be applied.

CA-4.6.6

If there are three or more assessments by eligible ECAIs chosen by an Islamic bank licensee which map into different risk weights, the assessments corresponding to the two lowest risk weights must be referred to and the higher of those two risk weights must be applied.

CA-4.6.7

Where a bank invests in a particular issue that has an issue-specific assessment, the risk weight of the claim will be based on this assessment. Where the bank's claim is not an investment in a specific assessed issue, the following general principles apply:

CA-4.6.8

Whether the Islamic bank licensees intends to rely on an issuer- or an issue-specific assessment, the assessment must take into account and reflect the entire amount of credit risk exposure the Islamic bank licensees has with regard to all payments owed to it.²⁵

²⁵ For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with repayment of both principal and interest.

CA-4.6.9

In order to avoid any double counting of credit enhancement factors, no recognition of credit risk mitigation techniques will be taken into account if the credit enhancement is already reflected in the issue specific rating (see Paragraph CA-4.7.3).

CA-4.6.10

Where unrated exposures are risk weighted based on the rating of an equivalent exposure to that borrower, the general rule is that foreign currency ratings must be used for exposures in foreign currency. Domestic currency ratings, if separate, must only be used to risk weight claims denominated in the domestic currency.

CA-4.6.11

However, when an exposure arises through an Islamic bank licensee's participation in a credit facility that has been extended, or has been guaranteed against convertibility and transfer risk, by certain MDBs, its convertibility and transfer risk can be considered by CBB, on a case by case basis, to be effectively mitigated. To qualify, MDBs must have preferred creditor status recognised in the market and be included in MDB's qualifying for 0% risk rate under Paragraph CA-4.2.8. In such cases, for risk weighting purposes, the borrower's domestic currency rating may be used instead of its foreign currency rating. In the case of a guarantee against convertibility and transfer risk, the local currency rating can be used only for the portion that has been guaranteed. The portion of the loan not benefiting from such a guarantee will be risk-weighted based on the foreign currency rating.

CA-4.6.12

For risk-weighting purposes, short-term assessments are deemed to be issue-specific. They can only be used to derive risk weights for claims arising from the rated facility. They cannot be generalised to other short-term claims, except under the conditions of Paragraph CA-4.6.14. In no event can a short-term rating be used to support a risk weight for an unrated long-term claim. Short-term assessments may only be used for short-term claims against banks and corporates. The table below provides a framework for banks' exposures to specific short-term facilities, such as a particular issuance of commercial paper: For any Sharia contract with an original maturity of up to three months that is not rolled over, the short-term RW as set out in the following table must be applied.

²⁶ The notations follow the methodology used by Standard & Poor's and by Moody's Investors Service. The A-1 rating of Standard & Poor's includes both A-1+ and A-1-.

²⁷ This category includes all non-prime and B or C ratings.

CA-4.6.13

If a short-term rated facility attracts a 50% risk-weight, unrated short-term claims cannot attract a risk weight lower than 100%. If an issuer has a short-term facility with an assessment that warrants a risk weight of 150%, all unrated claims, whether long-term or short-term, must also receive a 150% risk weight, unless the Islamic bank licensee uses recognised credit risk mitigation techniques for such claims.

CA-4.6.14

For short-term claims on Islamic bank licensees, the interaction with specific short-term assessments is expected to be the following:

CA-4.6.15

When a short-term assessment is to be used, the institution making the assessment needs to meet all of the eligibility criteria for recognising ECAIs as presented in Paragraph CA-4.6.1 in terms of its short-term assessment.

CA-4.6.16

External assessments for one entity within a corporate group must not be used to risk weight other entities within the same group.

CA-4.6.17

Unsolicited ratings should be treated as unrated exposures.

CA-4.7.1

The exposure in respect of an obligor or other, counterparty can be further adjusted or reduced by taking into account the credit risk mitigation (CRM) techniques employed by Islamic banks (off-balance sheet items will first be converted into on-balance sheet equivalents prior to the CRM being applied).

CA-4.7.2

The effects of CRM will not be double counted. Therefore, no additional recognition of CRM for regulatory capital purposes is applicable on claims for which an issue-specific rating is used that already reflects that CRM.

CA-4.7.3

While the use of CRM techniques reduces or transfers credit risk, it simultaneously may increase other risks (residual risks). Residual risks include legal, operational, liquidity and market risks. Therefore, it is imperative that Islamic bank licensees employ robust procedures and processes to control these risks, including strategy; consideration of the underlying credit; valuation; policies and procedures; systems; control of roll-off risks; and management of concentration risk arising from the Islamic bank licensee's use of CRM techniques and its interaction with the Islamic bank licensee's overall credit risk profile. Where these risks are not adequately controlled, the CBB may impose additional capital charges or take supervisory actions.

CA-4.7.4

The collateral used as a part of CRM must be compliant with Shari'a requirements. The collateralisation²⁸ must be properly documented in a security agreement or in the body of a contract to the extent permissible by Shari'a, and must be binding on all parties and legally enforceable in the relevant jurisdictions. The Islamic bank licensee must ensure that the CRM documentation is legally enforceable and must carry out periodic reviews to confirm its enforceability at all times. The Islamic bank licensee cannot recognise a commitment to provide collateral or a guarantee as an eligible CRM unless such a commitment is actually executed.

²⁸ Generally, in banks such collateralisation takes place under the concept of "Rahn" or "Kafalah".

CA-4.7.5

There should be a negligible positive correlation, if any, between the value of collateral and the credit quality of a counterparty. Consequently, securities issued by a counterparty or its related entities are not eligible as collateral.

CA-4.7.6

For a collateralised transaction — such as Shari'a-compliant alternatives to repo/reverse repo or borrowing/lending of Sukuk and Islamic securities — capital requirements must be applicable on either side of the transaction.

CA-4.7.7

Capital relief for the use of a guarantee is given when the following conditions are satisfied:

CA-4.7.8

It is permitted to have a range of guarantors to cover the exposure. Guarantees issued by parties with a lower RW than the counterparty will result in a reduction of the capital charge because the credit exposure covered by the guarantee is assigned the RW of guarantor. The RW applicable to the uncovered portion remains that of the underlying counterparty.

CA-4.7.9

Takaful is not allowed as a credit risk mitigation technique.

CA-4.7.10

Assets leased under Ijarah or IMB contracts fulfil a function similar to that of collateral, in that they may be repossessed by the lessor in the event of default by the lessee.

CA-4.7.11

The pledged asset must be a Shari'a-compliant asset of monetary value that can be lawfully owned, and is saleable, specifiable, deliverable and free of encumbrance. The pledge must be legally enforceable. The asset pledged may either be the underlying asset or any other eligible financial collateral owned by the customer (see Paragraph CA-4.7.25). The pledge of an asset owned by a third party is subject to the owner's consent to the pledge. Murabaha facilities secured by real estate are covered separately in Paragraphs CA-4.2.19 to CA-4.2.20.

CA-4.7.12

The pledger can authorise the Islamic bank licensee, as the pledgee, to sell the asset and to offset the amount due against the sales proceeds without recourse to the courts. Alternatively, the Islamic bank licensee can demand the sale of the pledged asset in order to recover the amount due. Any surplus from the sale proceeds is to be returned to the pledger, and any shortfall must be treated as an unsecured exposure that ranks pari passu with other unsecured creditors when the debtor is declared insolvent.

CA-4.7.13

In case an Islamic bank licensee takes collateral of an asset pledged more than once, the collateral of the Islamic bank licensee must be ranked either pari passu to the collaterals of other earlier pledgees with their consent, or junior to the earlier pledgees, in which case the Islamic bank licensee's claim is limited to the residual value of the pledged asset after payment is made to earlier pledgees. The Islamic bank licensee must take the residual value after deducting a haircut under the simple approach or the comprehensive approach (the standard supervisory haircuts or the internal haircuts) to offset its credit exposure but must first ascertain the recoverable value of the asset after taking into consideration the Islamic bank licensee's position as a pledgee as to whether it ranks pari passu with the other pledgee(s) or ranks junior to a pledgee that is registered earlier than the Islamic bank licensee.

CA-4.7.14

The types of collateral are eligible for relief in respect of the CRM techniques outlined in Paragraphs CA-4.7.7 to CA-4.7.13 include:

²⁹ Must be supported by an agreement or documentation that gives the bank the right of set-off against the amount of receivables due. The treatment of netting of such deposits are outlined in Paragraph CA-4.2.30.

CA-4.7.14A

Credit default guarantee provided by Tamkeen is recognised as an eligible credit risk mitigant.

CA-4.7.15

Any portion of the exposure which is not collateralised must be assigned the RW of the counterparty.

CA-4.7.16

Capital relief against the collateral can be granted based on either the simple or the comprehensive approach as described below in reducing the risk exposures in the banking book. Islamic bank licensees must approach the CBB for approval before using the comprehensive approach. Islamic bank licensees can use partial collateralisation in both approaches. Maturity mismatches between exposure and collateral will only be allowed under the comprehensive approach.

CA-4.7.17

The Islamic bank licensee can substitute the RW of the collateral for the RW of the counterparty for the collateralised portion of the exposure, subject to the collateral being pledged for at least the duration of the contract. The minimum RW of the collateralised portion is not lower than 20% (with a limited exception in Paragraph CA-4.7.19B).

CA-4.7.18

The uncollateralised portion of the exposure continues to be assigned the RW of the counterparty.

CA-4.7.19

A 0% RW is applied to the collateralised portion under the simplified method where the exposure and the collateral are denominated in the same currency, and the collateral consists of any of the following:

CA-4.7.20

Shari'a-compliant hedging instruments which are normally traded OTC can be given a RW of 0% provided the conditions set out in the following are met. (In case these conditions are not fulfilled, see Paragraphs CA-4.5.10 and CA-4.5.11 for calculating the credit equivalent using the Current Exposure Method).

CA-4.7.21

In the comprehensive approach, the exposure to a counterparty is adjusted based on the collateral used without the 20% floor of the simple approach. The Islamic bank licensee must adjust both the amount of the exposure to the counterparty and the value of the collateral shown in Paragraph CA-4.7.25, using haircuts and add-ons in order to reflect variations in the value of both the exposure and the collateral due to market movements. The resultant volatility-adjusted amount of exposure and collateral is used for the calculation of capital requirements for the underlying risk exposure. In most cases, the adjusted exposure is higher than the unadjusted exposure after application of the add-on and adjusted collateral is lower than the unadjusted collateral after application of the haircut, unless either of them is cash. An additional downward adjustment for collateral must be made if the underlying currencies of exposure and collateral are not denominated in the same currency, so as to take account of foreign exchange fluctuations in the future.

CA-4.7.22

Risk-weighted assets must be calculated by calculating the difference between the volatility adjusted exposure and the volatility-adjusted collateral and multiplying this adjusted exposure by the RW of the counterparty.³⁰

³⁰ This calculation will be carried out when the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount, including any additional adjustment for foreign exchange risk.

CA-4.7.23

The formula for calculation of the adjusted exposure after incorporating risk mitigation using the comprehensive approach is as follows:

E* = max {0, [E x (1 + He) — C x (1 - Hc - Hfx)]}, where:
E* = Adjusted exposure amount after risk mitigation
E = Exposure amount
He = Applicable add-on for exposure
C = The current value of underlying collateral
Hc = Applicable haircut for collateral
Hfx = Applicable haircut for foreign exchange exposure, in case exposure and collateral have dissimilar currencies

CA-4.7.24

If more than one asset is involved in a collateralised transaction, the haircut on the basket (H) will be a weighted sum of applicable haircuts to each asset (Hi), with asset weights (ai) measured by units of currency — that is, H = Σ ai Hi.

CA-4.7.25

Both the amount of exposure to counterparty and the value of collateral received are adjusted by using standard supervisory add-ons and haircuts as set out below with the exception of any exposures collateralised by own securities which are subject to treatment under Subparagraph CA-4.7.14(d) (and Chapter CA-2 as applicable):

^* Collateral denominated in a different currency will also be subject to an additional 8% haircut to cater for foreign exchange risk (see Paragraph CA-4.7.26.

³¹ Includes PSEs and MDBs

CA-4.7.26

The standard haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-to-market). For transactions in which the Islamic bank licensee lends non-eligible instruments (e.g. non- investment grade securities), the haircut to be applied on the exposure must be the same as the one for equity traded on a recognised exchange that is not part of a main index.

CA-4.7.27

A maturity mismatch is a situation where the residual maturity of the CRM is less than that of the underlying credit exposure. In the case of a maturity mismatch with the CRM having a maturity of less than one year, the CRM is not recognised. This means that a CRM with a maturity mismatch is only permitted where its original maturity is at least one year. The simple approach must not be used for CRM with maturity mismatches.

CA-4.7.28

The following adjustment must be applied for a CRM with a maturity mismatch:

Pa = P x (t -0.25) / (T – 0.25), where:

Pa = adjusted value of risk mitigation

P = value of risk mitigation used (e.g. collateral or guarantee amount)

T = min (5, residual maturity of the exposure) in years

t = min (T, residual maturity of the risk mitigation) in years

CA-4.7.29

A placement of funds made under a Mudarabah contract may be subject to a Shari'a-compliant guarantee from a third party. Such a guarantee relates only to the Mudarabah capital, not to the 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 Mudarib as a counterparty. Otherwise, the RW of the Mudarib must apply; that is, a RW for "equity exposure in banking book" applies, as per Paragraphs CA-4.8.16 to 4.8.18.

CA-4.7.30

In a Mudarabah investment in project finance, collateralisation of the progress payments made by the ultimate customers (e.g. by means of a "repayment account" — see Paragraph CA-4.8.18) can be used to mitigate the exposure to unsatisfactory performance by the Mudarib.

CA-4.7.31

An Islamic bank licensee may also place liquid funds with a central bank or another Islamic bank licensee on a short-term Mudarabah basis in order to obtain a return on those funds. Such placements serve as an interbank market transaction with maturities ranging from overnight up to three months, but the funds may be withdrawn on demand before the maturity date, in which case the return is calculated proportionately on the basis of duration and amount. Although from a juristic point of view the amounts so placed do not constitute debts, since (in the absence of misconduct or negligence) Mudarabah capital does not constitute a liability for the Mudarib, in practice the operation of this interbank market requires that the Mudarib should effectively treat them as liabilities. Hence, an Islamic bank licensee placing funds on this basis may treat them as cash equivalents and, for risk-weighting purposes, apply the RW applicable to the Mudarib as counterparty.

CA-4.7.32

If an exposure is covered by multiple CRM techniques (e.g. an exposure partially covered by both collateral and a guarantee), the Islamic bank licensee must segregate the exposure into segments covered by each type of CRM technique. The calculation of risk-weighted assets must be made separately for each segment. Similarly, if a single CRM has differing maturities, they must also be segregated into separate segments.

CA-4.8.3

In assigning the RW, consideration is given to the intent of the profit-sharing investment, and to the nature of the underlying assets. For the purpose of determining minimum capital requirements, the RW is applied based on Paragraphs CA-4.8.4 to CA-4.8.22.

CA-4.8.4

Financing on a Musharakah or Mudarabah basis of a commercial enterprise to undertake a business venture can expose an Islamic bank licensee to capital impairment risk as well as credit risk, to an extent that depends on the structure and purpose of the financing and the types of assets in which the funds are invested. Commonly, an Islamic bank licensee would invest in a commercial enterprise with the intention of holding the investment for an indefinite period or with a view to eventual sale (as in the case of venture capital or private equity investments). As an equity investor, the Islamic bank licensee's rights and entitlements are subordinated to the claims of secured and unsecured creditors.

CA-4.8.5

Capital impairment risk is the risk of losing the amount invested in an enterprise or in the ownership of an asset. Such impairments may arise for two kinds of reasons:

CA-4.8.6

Bearing in mind the relatively risky nature of financing based on profit-sharing modes, the CBB sets out some prudential conditions on Islamic bank licensees that invest IAH funds in such financing either directly or by commingling the funds of IAH with those of shareholders in such financing (see module CM). Unrestricted investment account holders (UIAH) typically have a small risk appetite and are content with an investment which has a relatively low risk and low returns.

CA-4.8.7

The RW for investments in commercial enterprises is calculated according to either of the following methods:

CA-4.8.8

For Musharakah or Mudarabah investments in commercial enterprises whose common shares are listed on a recognised security exchange, a 300% RW must be applied. For Musharakah or Mudarabah investments in all other enterprises, a 400% RW is applicable.

CA-4.8.9

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CA-4.8.10

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CA-4.8.11

In project finance, the CBB may permit an Islamic bank licensee to employ an alternative approach, namely the supervisory slotting criteria. Under this method, an Islamic bank licensee is required to map its internal risk grades into four supervisory categories for specialised financing, as described in Appendix CA-5. Each of these categories is associated with a specific RW, as given in the following. These RWs include an additional fixed factor of 20% RW to cater for the potential decline in the Mudarabah's or Musharakah's net asset value.

CA-4.8.12

The Islamic bank licensee's position in a diminishing Musharakah entails two kinds of exposures:

³³ Diminishing Musharakah contracts typically contain a clause whereby, in the event of a default by the partner in making a due payment, the bank has the right to terminate the contract and to exercise a put option requiring the partner to buy out the whole of the bank's remaining share of the investment. However, a financially distressed partner will most likely be unable to do so.

CA-4.8.13

Based on Paragraph CA-4.8.13, when a diminishing Musharakah contract is related to a specific fixed asset/real estate leased to a customer under an Ijara contract, the Islamic bank licensee's credit exposure is similar to an exposure under a Musharakah with an Ijara sub-contract. In this case, the 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 100% RW on residual value of an asset. In case the counterparty is unrated, a RW of 100% applies.

CA-4.8.14

If the exposure under the diminishing Musharakah contract consists of working capital finance in the customer's business venture, the Islamic bank licensee must measure its credit risk similarly to an equity exposure held in the banking book, as set out in Paragraphs CA-4.8.4 to CA-4.8.11 (Commercial enterprise to undertake a business venture). This treatment is, however, subject to the consideration of any third-party guarantee to make good impairment losses. In that case, the RW of the guarantor is substituted for that of the outstanding balance of the Musharakah investment for the amount of any such guarantee. Moreover, subject to obtaining prior approval from the CBB, an Islamic bank licensee can use the supervisory slotting method, based on the criteria set out in Appendix CA-6 (diminishing Musharakah).

CA-4.8.15

Such a holding is not a trading book exposure, and thus the "look-through" principle, whereby the RW of the exposure would be that of the underlying assets, does not apply and the exposure is that of an equity position in the banking book. Banking book investments would not normally include investments in common shares or Islamic collective investment schemes that are publicly listed. However, if such an investment is in an entity or Islamic collective investment scheme (consisting predominantly of equity instruments/stocks) that is publicly listed on a recognised securities exchange, the holding being not for short-term resale or trading purposes, a 300% RW must be applied, consistent with the simple RW method. Likewise, a 400% RW is applied to all other equity holdings. The exposure in such investments must be measured at the carrying values of the investments, according to IFRS or AAOIFI as applicable.

CA-4.8.16

An Islamic bank licensee can advance funds to a construction company which 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 Mudarabah structure, the Islamic bank licensee as investor advances funds as Rabb-al-Mal to the construction company as Mudarib for the construction project, and is thus entitled to a share of the profit of the project but must bear 100% of any loss. In most cases, the Islamic bank licensee has no direct or contractual relationship with the ultimate customer, but in such a structure the Islamic bank licensee stipulates 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.

CA-4.8.17

Where Paragraph CA-4.8.17 applies, the Islamic bank licensee is exposed to the risk on the amounts advanced to the Mudarib under the Mudarabah contract, but this risk would be mitigated by the amounts received from the ultimate customer into the "repayment account" which are effectively collateralised. Under the Mudarabah contract the amounts advanced by the Islamic bank licensee to the Mudarib would normally be treated under credit risk as "equity positions in the banking book", the use of the structure involving a "repayment account", whereby the ultimate customer makes payments into such an account with the Islamic bank licensee instead of making payments directly to the Mudarib, has the effect of substituting the credit risk of the ultimate customer for that of the Mudarib to the extent of the collateralised balance of the "repayment account".

CA-4.8.18

In addition to credit risk (i.e. in the absence of a repayment account, the risk that the Mudarib has received payment from the ultimate customer but fails to pay the Islamic bank licensee, or, if the repayment account is used, that the ultimate customer fails to pay), the Islamic bank licensee is exposed to capital impairment in the event that the project results in a loss. The proposed RW and impact of credit risk mitigation are explained in Section CA-4.7.

CA-4.8.19

An Islamic bank licensee can establish joint ownership of tangible fixed assets (such as cars, machinery, etc.) with a customer on a Musharakah basis, the assets being leased or sold on an Ijara or a Murabaha basis, respectively. In these cases, the "look-through" principle (whereby the RW is that of the underlying contract) applies.

CA-4.8.20

In the case of Ijara, ownership of such assets can produce rental income for the partnership, through leasing the assets to third parties by means of Ijara contracts. In this case, the risk of the Musharakah investment is that of the underlying Ijara contracts — that is, credit risk mitigated by the "quasi-collateral"³⁴ represented by the leased assets. In the event the asset is leased to the Islamic bank licensee's partner as a customer instead of to a third party, the credit risk relates to the partner's obligation to pay the lease rentals. This Musharakah investment is assigned a RW based on the credit standing of the counterparty/lessee, as rated by a CBB-approved ECAI, plus a 100% RW on the residual value of the Ijara asset. In the event the counterparty is unrated, a RW of 100% applies.

³⁴ Strictly speaking, Ijara assets do not provide collateral to the lessor, as the latter owns the assets, but can repossess them in the event of default by the lessee. This provides what may be called "quasi-collateral".

CA-4.8.21

In the case of Murabaha, the Islamic bank licensee is entitled to its share of income (mark-up) generated from selling the assets to third parties. The Islamic bank licensee as a capital contributor is exposed to credit risk in respect of the Murabaha receivables from the buyer/counterparty. This Musharakah investment must be assigned a RW based on the credit standing of the counterparty/buyer, as rated by a CBB-approved ECAI. In the event the counterparty is unrated, a RW of 100% applies.