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  • Supervisory Slotting Method

    • 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.

      Supervisory Categories Strong Good Satisfactory Weak
      Risk weights 90% 110% 135% 270%
      January 2015

    • CA-4.8.12

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

      (a) The amounts due from the partner to buy out the agreed shares of the investment on the agreed dates are subject to credit risk in respect of the partner's ability and willingness to pay.33 The Islamic bank licensee's selling price for each share of ownership being transferred is based either on the fair value of that share at the date of the partial transfer of ownership (which exposes the Islamic bank licensee to capital gains or losses and hence to capital impairment risk) or at a price agreed upon at the time of entering into the contract. The Islamic bank licensee's credit risk exposure in respect of the Musharakah investment 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. If there is a third-party guarantee to make good impairment losses, the RW of the guarantor is substituted for that of the outstanding balance of the Musharakah investment for the amount of any such guarantee; and
      (b) As a joint-owner, the Islamic bank licensee is entitled to its share of income generated from its share of the underlying assets of the Musharakah, such as Ijara lease rentals (e.g. when a home purchase plan is provided by an Islamic bank licensee on the basis of diminishing Musharakah). The rental payable by the partner/customer as Ijara lessee is adjusted periodically to reflect the Islamic bank licensee's remaining ownership share in the asset. The Islamic bank licensee is exposed to credit risk in respect of non-payment of the rentals receivable from the partner/customer.

      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.

      January 2015

    • 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.

      January 2015

    • 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).

      January 2015