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.