CA-A.1.1

The purpose of this Module is to set out the Central Bank of Bahrain (CBB)'s capital adequacy Rules and provide guidance on the risk measurements for the calculation of capital requirements by Bahraini Islamic bank licensees. This requirement is supported by Article 44(c) of the Central Bank of Bahrain and Financial Institutions Law (Decree No. 64 of 2006).

CA-A.1.2

Principle 9 of the Principles of Business requires that Islamic bank licensees maintain adequate human, financial and other resources, sufficient to run their business in an orderly manner (see Section PB-1.9). In addition, Condition 5 of CBB's Licensing Conditions (Section LR-2.5) requires Islamic bank licensees to maintain financial resources in excess of the minimum requirements specified in Module CA (Capital Adequacy).

CA-A.1.3

This Module also sets out the minimum leverage requirements which Islamic bank licensees (referred to in Section CA-B.1) must meet as a condition of their licensing.

CA-A.1.4

The requirements specified in this Module vary according to the inherent risk profile of a licensee, and the volume and type of business undertaken. As one of the principal objectives of the CBB (as outlined in Article 3 of the CBB Law 2006) is the protection of depositors, it is essential to ensure that the capital recognised in regulatory capital measures is readily available for those depositors and to ensure that Islamic bank licensees hold sufficient capital to provide some protection against unexpected losses in the normal course of business, and otherwise allow Islamic banks to effect an orderly wind-down of their operations. The minimum capital requirements specified here may not be sufficient to absorb all unexpected losses. The CBB therefore may impose more stringent capital requirements than those stated in this Module on certain banks taking into account the riskiness of the activities conducted by the concerned bank (see Paragraph CA-A.1.5A).

CA-A.1.5

The CBB requires that Islamic bank licensees maintain adequate capital, in accordance with the requirements of this Module, against their risks. In particular, all Bahraini Islamic bank licensees are required to maintain capital adequacy ratios or CARs (both on a solo and a consolidated basis where applicable) above the minimum levels set out in Chapters CA-B and CA-2. Failure to remain above these ratios will result in enforcement and other measures as outlined in Section CA-1.2 and Module EN. The detailed methodology for calculating the CARs is set out in the instructions for the form PIRI.

CA-A.1.5A

All Bahraini Islamic bank licensees must maintain their own target capital ratios above the supervisory CARs mentioned in Section CA-B.2. Each concerned licensee must observe individual target ratios as agreed with the CBB on a case-by-case basis subject to a methodology to be disclosed in due course.

CA-A.1.6

This Module provides support for certain other parts of the Rulebook, mainly:

CA-A.1.7

This Module contains the CBB's Directive (as amended from time to time) relating to the capital adequacy of Islamic bank licensees, and is issued under the powers available to the CBB under Article 38 of the CBB Law. The Directive in this Module is applicable in its entirety to all Bahraini Islamic bank licensees.

CA-A.1.8

For an explanation of the CBB's rule-making powers and different regulatory instruments, see Section UG-1.1.

CA-A.2.2

The contents retained from the previous Module (Capital Adequacy — Islamic Banks) are effective from the dates depicted above.

CA-B.1.4

Generally, wherever possible, the assets and liabilities of banking subsidiaries must be consolidated on a line-by-line basis using the risk-weighting and other rules and guidance in this Module. In some cases, foreign banking subsidiaries are subject to slightly differing rules by their host regulator. In such cases it may be more convenient to add in the risk-weighted assets of the subsidiary as calculated by host rules rather than by adding in the assets of the subsidiary and subjecting them to CBB requirements and risk weights. This process of using host risk-weights instead of CBB risk-weights is termed 'aggregation'. Also host rules may treat some capital items differently to CBB rules. For example, T2 instruments may have different rules in host countries. There may therefore need to be a 'haircut' to such capital instruments, if the amount allowed by the host regulator is different to the amount of the investment by the parent bank.

CA-B.1.5

For the reasons outlined in CA-B.1.2A to CA-B.1.4, banks must agree the proposed regulatory consolidation or aggregation approach for banking subsidiaries with the CBB and their external auditor.

CA-B.1.6

If a banking subsidiary is to be consolidated by way of aggregation, the capital and risk weighted assets (RWAs) of the non-resident entity must be shown separately. The parent bank will be required to aggregate the subsidiary's eligible capital and RWAs (based on the risk weighting of assets reported by the subsidiary to its host central bank) with its own eligible capital and RWAs respectively.

CA-B.1.7

Appropriate adjustments must be made to eliminate intra-group exposures.

CA-B.1.8

If a bank in Bahrain is a subsidiary of a non-resident parent bank, the capital adequacy of such bank must be determined on a standalone basis.

CA-B.1.9

Majority-owned or controlled financial entity subsidiaries must be adequately capitalised to reduce the possibility of future potential losses to the parent bank. The parent bank must monitor actions taken by the subsidiary to correct any capital shortfall and, if it is not corrected in a timely manner, the shortfall must also be deducted from the parent bank's solo and consolidated capital for regulatory capital purposes.

CA-1.1.2

Consolidated Total Capital consists of the sum of the following elements:

CA-1.1.3

Consolidated Total risk-weighted assets are determined by:

CA-1.1.4

For the measurement of their credit risks, Islamic bank licensees measure the risks in the standardised approach, applying the measurement framework described in Chapters CA-3, CA-4, and CA-9 (real estate) and subject to the credit mitigation techniques outlined in Section CA-4.7 of this Module and subject to any adjustments described in Paragraphs CA-1.1.9 onward in relation to assets funded by Profit Sharing Investment Accounts (PSIAs).

CA-1.1.5

The Sukuk and securitisation framework is set out in Chapter CA-8. Islamic bank licensees must apply this framework for determining regulatory capital requirements on exposures arising from traditional securitisations or sukuks.

CA-1.1.6

For the measurement of their operational risks, Islamic bank licensees have a choice, subject to notification to the CBB, between two broad methodologies:

CA-1.1.6A

For the purpose of Sub-paragraph CA-1.1.6 (b), a licensee must provide appropriate justification and seek CBB’s prior approval, if it wishes to revert from the standardised approach to the basic indicator approach.

CA-1.1.7

For the measurement of market risk in the trading book, Islamic bank licensees must measure the risks in a standardised approach, applying the measurement frameworks described in Chapter CA-5 of this Module. Market risk inherent in certain Shari'a compliant products is outlined in detail in Chapter CA-3. The treatment of market risk positions funded by PSIAs is given in Paragraphs CA-1.1.9 onward.

CA-1.1.8

In light of Paragraphs CA-1.1.3 to CA-1.1.7, each Islamic bank licensee's overall capital requirement consists of:

CA-1.1.9

The capital amount of PSIAs is not guaranteed by the Islamic bank licensee due to the profit-sharing nature of the underlying Mudarabah contract. Therefore, any losses arising from investments or assets financed by PSIA are to be borne by the Investment Account Holders. Nevertheless, IAH are not liable for any losses arising from the Islamic bank licensee's negligence, misconduct, fraud or breach of its investment mandate, which is characterised as a fiduciary risk and considered part of the Islamic bank licensee's operational risk.

CA-1.1.10

An Islamic bank licensee may be constructively obliged to smooth the profits payout to Unrestricted PSIAs (UPSIAs). A necessary consequence of some of these smoothing practices adopted by Islamic bank licensees is that a portion of risk (i.e. volatility of the stream of profits) arising from assets financed by UPSIAs is effectively transferred to the Islamic bank licensee's own capital, a phenomenon known as "displaced commercial risk" (DCR).

CA-1.1.11

The CBB requires regulatory capital to be held to cater for DCR and the operational risk mentioned in Paragraph CA-6.1.1 in view of the residual risk to the Islamic bank licensee and its shareholders. To be prudent, the CBB requires Islamic bank licensees to provide regulatory capital to cover a minimum requirement arising from 30% of the risk weighted assets and contingencies financed by the UPSIAs. Therefore, for the purpose of calculating its Capital Adequacy Ratio (CAR), the risk-weighted assets of an Islamic bank licensee consist of the sum of the risk-weighted assets financed by the Islamic bank licensee's own capital and liabilities, plus 30% (shown below as α) of the risk-weighted assets financed by the Islamic bank licensee's UPSIAs as outlined in Paragraph CA-1.1.12.

CA-1.1.12

For the purpose of this Module the consolidated CAR is calculated by applying the Total Capital (as defined in Paragraph CA-1.1.2) to the numerator and risk-weighted assets (RWAs) as defined in Paragraph CA-1.1.3) to the denominator as shown below.

Plus

α [RWAs funded by UPSIAs^a (Credit + Market Risks) -
PER and IRR of UPSIAs]}

CA-1.1.13

All transactions, including forward sales and purchases, must be included in the calculation of capital requirements as from the date on which they were entered into. Although regular reporting takes place quarterly, Islamic bank licensees must manage their risks in such a way that the capital and leverage requirements are being met on a continuous basis, i.e. at the close of each business day. Islamic bank licensees must not "window-dress" by showing significantly lower credit or market risk positions on reporting dates. Islamic bank licensees must maintain strict risk management systems to ensure that intra-day exposures are not excessive. If an Islamic bank licensee fails to meet the capital requirements of this Module, the Islamic bank licensee must take immediate measures to rectify the situation as detailed in Section CA-1.2.

CA-1.1.14

An Islamic bank licensee's solo capital adequacy ratio is calculated by dividing its Solo Total Capital by its Solo risk-weighted assets as described in Paragraph CA-1.1.15 and CA-1.1.16 without consolidating the assets and liabilities of subsidiaries referred to Paragraph CA-B.1.2A into the balance sheet of the parent bank.

CA-1.1.15

Solo Total Capital consists of the sum of the following elements:

CA-1.1.16

Solo Total risk-weighted assets are determined by:

CA-1.1.17

For the purpose of this Module the solo CAR is calculated by applying the Solo Total Capital (as defined in Paragraph CA-1.1.15) to the numerator and solo risk-weighted assets (RWAs) as defined in Paragraph CA-1.1.16) to the denominator as shown below.

CA-2.1.1

The predominant form of T1 capital must be common shares and retained earnings (hereafter referred to as CET1). Deductions from capital and prudential filters are applied at the level of CET1 (see CA-2.1 to CA-2.4 for a more detailed explanation). The remainder of the T1 capital must be comprised of instruments that are subordinated, have fully discretionary non-cumulative dividends or coupons and have neither a maturity date nor an incentive to redeem.

CA-2.1.2

CET1 capital consists of the sum of:

CA-2.1.2A

For unrealised fair value reserves relating to financial instruments to be included in CET1 Capital, Islamic bank licensees and their auditor must only recognise such gains or losses that are prudently valued and independently verifiable (e.g. by reference to market prices). The CBB will closely review the components and extent of unrealised gains and losses and will exclude any that do not have reference to independent valuations (i.e. those made by bank management alone will not be included) or which are not deemed to be made on a prudent basis. As such, the prudent valuations, and the independent verification thereof, are mandatory. Unrealised gains and losses that have resulted from changes in the fair value of liabilities that are due to changes in the bank's own credit risk must be derecognised in the calculation of CET1 .

CA-2.1.3

For a common share to be included in CET1, it must meet the following criteria:

CA-2.1.4

AT1 capital consists of the sum of:

CA-2.1.5

[This Paragraph has been left blank.]

CA-2.1.6

For an instrument to be included in AT1, it must meet or exceed all the criteria below:

CA-2.1.7

[This paragraph has been left blank.]

CA-2.1.7A

The issuance of any new shares as a result of a trigger event must occur prior to any public sector injection of capital so that the capital provided by the public sector is not diluted.

CA-2.1.7B

Where an issuing bank or SPV is part of a banking group and the issuer wishes the instrument to be included in the total capital of the group (in addition to its solo capital where applicable), the terms and conditions must specify an additional trigger event.

CA-2.1.7C

Any common stock paid as compensation to the holders of the instrument must be common stock of either the issuing bank or the parent bank of the group (including any successor in resolution).

CA-2.1.7D

For the purposes of Subparagraph CA-2.1.6(o), the following provisions apply to AT1 instruments accounted for as liabilities:

CA-2.1.7E

Where the provisions governing AT1 instruments require them to be converted into CET1 instruments upon the occurrence of a trigger event, those provisions must specify either of the following:

CA-2.1.7F

Where the provisions governing AT1 instruments require their principal amount to be written down upon the occurrence of a trigger event, the write down must reduce all the following:

CA-2.1.7G

Write down or conversion of an AT1 instrument must, under the applicable accounting framework, generate items that qualify as CET1 items.

CA-2.1.7H

The amount of AT1 instruments recognised in AT1 items is limited to the minimum amount of CET1 items that would be generated if the principal amount of the AT1 instruments were fully written down or converted into CET1 instruments.

CA-2.1.7I

The aggregate amount of AT1 instruments that is required to be written down or converted upon the occurrence of a trigger event must be no less than the lower of the following:

CA-2.1.7J

When a trigger event occurs Islamic bank licensees must do the following:

CA-2.1.7K

A Islamic bank licensee issuing AT1 instruments that convert to CET1 on the occurrence of a trigger event must ensure that its authorised share capital is at all times sufficient, for converting all such convertible AT1 instruments into shares if a trigger event occurs.

CA-2.1.7L

All necessary authorisations must be obtained at the date of issuance of such convertible AT1 instruments. The Islamic bank licensee must maintain at all times the necessary prior authorisation from the CBB to issue the CET1 instruments into which such AT1 instruments would convert upon occurrence of a trigger event.

CA-2.1.7M

An Islamic bank licensee issuing AT1 instruments that convert to CET1 on the occurrence of a trigger event must ensure that there are no procedural impediments to that conversion by virtue of its incorporation or statutes or contractual arrangements.

CA-2.1.7N

The following must apply where, in the case of an AT1 instrument, the conditions laid down in Paragraph CA-2.1.6 cease to be met:

CA-2.1.8

T2 capital consists of the sum of the following items

CA-2.1.9

The treatment of instruments issued out of consolidated subsidiaries of the Islamic bank licensee and the regulatory adjustments applied in the calculation of T2 Capital are addressed in Section CA-2.3.

CA-2.1.10

For an instrument to be included in T2 capital (see CA-2.1.8(a)), it must meet all the criteria below:

CA-2.1.10A

[This paragraph has been left blank.]

CA-2.1.10B

The issuance of any new shares as a result of a trigger event must occur prior to any public sector injection of capital so that the capital provided by the public sector is not diluted.

CA-2.1.10C

Where an issuing bank or SPV is part of a banking group and the issuer wishes the instrument to be included in the total capital of the group (in addition to its solo capital where applicable), the terms and conditions must specify an additional trigger event.

CA-2.1.10D

Any common stock paid as compensation to the holders of the instrument must be common stock of either the issuing bank or the parent bank of the group (including any successor in resolution).

CA-2.1.10E

For the purposes of Subparagraph CA-2.1.10(j), the following provisions apply to T2 Sukuk instruments:

CA-2.1.10F

Where the provisions governing T2 instruments require them to be converted into CET1 instruments upon the occurrence of a trigger event, those provisions must specify either of the following:

CA-2.1.10G

Where the provisions governing T2 instruments require their principal amount to be written down upon the occurrence of a trigger event, the write down must reduce all the following:

CA-2.1.10H

Write down or conversion of a T2 instrument must, under the applicable accounting framework, generate items that qualify as CET1 items.

CA-2.1.10I

The amount of T2 instruments recognised in T2 items is limited to the minimum amount of CET1 items that would be generated if the principal amount of the T2 instruments were fully written down or converted into CET1 instruments.

CA-2.1.10J

The aggregate amount of T2 instruments that is required to be written down or converted upon the occurrence of a trigger event must be no less than the lower of the following:

CA-2.1.10K

When a trigger event occurs Islamic bank licensees must do the following:

CA-2.1.10L

An Islamic bank licensee issuing T2 instruments that convert to CET1 on the occurrence of a trigger event must ensure that its authorised share capital is at all times sufficient, for converting all such convertible T2 instruments into shares if a trigger event occurs.

CA-2.1.10M

All necessary authorisations must be obtained at the date of issuance of such convertible T2 instruments. The Islamic bank licensee must maintain at all times the necessary prior authorisation from the CBB to issue the CET1 instruments into which such T2 instruments would convert upon occurrence of a trigger event.

CA-2.1.10N

An Islamic bank licensee issuing T2 instruments that convert to CET1 on the occurrence of a trigger event must ensure that there are no procedural impediments to that conversion by virtue of its incorporation or statutes or contractual arrangements.

CA-2.1.10O

The following must apply where, in the case of a T2 instrument, the conditions laid down in Paragraph CA-2.1.10 cease to be met:

CA-2.1.11

Profit-sharing investment accounts of an Islamic bank licensee are not classified as part of the Islamic bank licensee's capital because they do not meet the above-mentioned criteria of T1 or T2 Capital. Furthermore, all the investment risk reserve (IRR) and a portion of the profit equalisation reserve (PER) belong to the equity of investment account holders, and thus are not part of the capital of the Islamic bank licensee. As the purpose of a PER is to smooth the profit payouts and not to cover losses, any portion of a PER that is part of the Islamic bank licensee's reserves should also not be treated as part of the regulatory capital of the Islamic bank licensee. The impact of PER and IRR has already been incorporated in the alpha component of the denominator of the formula for the calculation of the CAR, as outlined in Paragraph CA-1.1.12.

CA-2.2.1

CAR components and CARs outlined in Paragraph CA-B.2.1 must meet or exceed the following minimum ratios on a consolidated basis relative to total risk-weighted assets:

CA-2.2.1A

CAR components and CARs outlined in Paragraph CA-B.2.1 must meet or exceed the following minimum ratios on a solo basis relative to total risk-weighted assets:

CA-2.2.2

CET1 must be the predominant form of capital. Accordingly, the contribution of AT1 instruments towards the Minimum T1 Capital Ratios mentioned in Paragraphs CA-2.2.1 and CA-2.2.1A is limited to 1.5%.

CA-2.2.3

The limits on AT1 instruments and T2 instruments are based on the amount of CET1 after deductions pursuant to CA-2.4 (see Appendices CA-11 and CA-12 for examples of the threshold deduction effects and the caps).

CA-2.2.4

The contribution of T2 capital towards the Minimum Total Capital Ratios and Minimum Total Capital plus Capital Conservation Buffer Ratios mentioned in Paragraphs CA-2.2.1 (consolidated) and CA-2.2.1A (solo) is limited to 2.0%.

CA-2.2.5

To explain the limits outlined in Paragraph CA-2.2.4 on the contributions of AT1 and T2 Capital to T1 and Total Capital, a simple example is given below where an Islamic bank licensee on a consolidated basis has BD650mn of Core Equity Tier One Capital and BD200mn of AT1 and BD300mn of T1 Capital and BD10,000 mn of total risk-weighted assets:

This means that if the Islamic bank licensee only has BD650mn of CET1, it cannot comply with the additional Capital Conservation Buffer Requirement of 2.5% nor can it use excess AT1 or T2 Capital to meet this requirement. Although it would appear that the Islamic bank licensee has BD1,150mn of total capital, only BD1,000mn can be used to meet the minimum ratios. This example serves to underline the importance of CET1. Unless an Islamic bank licensee can meet the CET1 minimum CARs of 6.5% and 9.0% mentioned above, it may not be able to meet any of the other minimum capital adequacy ratios outlined in Paragraph CA-2.2.1. A separate example of the effect of the T2 cap is given in Appendix CA-12.

CA-2.3.1

In order for minority interest arising from the issue of common shares by a fully consolidated subsidiary of the Islamic bank licensee to be recognised in CET1 for the consolidated CAR calculation, it must meet the following conditions:

¹ For the purposes of this paragraph, any institution that is subject to the same minimum prudential standards and level of supervision as a bank may be considered to be a bank.

² Minority interest in a subsidiary that is a bank is strictly excluded from the parent bank's common equity if the parent bank or affiliate has entered into any arrangements to fund directly or indirectly minority investment in the subsidiary whether through an SPV or through another vehicle or arrangement. The treatment outlined above, thus, is strictly available where all minority investments in the bank subsidiary solely represent genuine third party common equity contributions to the subsidiary.

CA-2.3.2

The amount of minority interest meeting the criteria above that will be recognised in consolidated CET1 will be calculated as follows:

CA-2.3.2A

Appendix CA-1 outlines an example of the effect of the allocation of minority interest between the parent bank and minority shareholders in the fully consolidated subsidiary.

CA-2.3.3

AT1 capital instruments issued by a fully consolidated banking subsidiary of the Islamic bank licensee to third party investors (including amounts under Paragraph CA-2.3.2) may receive recognition in consolidated T1 capital only if the instruments would, if issued by the Islamic bank licensee, meet all of the criteria for classification as T1 capital. The amount of this AT1 capital that will be recognised in consolidated AT1 will exclude amounts recognised in consolidated CET1 under Paragraph CA-2.3.2 and will be calculated as follows:

CA-2.3.4

T2 capital instruments issued by a fully consolidated banking subsidiary of the Islamic bank licensee to third party investors (including amounts under Paragraphs CA-2.3.2 and CA-2.3.3) may receive recognition in consolidated Total Capital only if the instruments would, if issued by the Islamic bank licensee, meet all of the criteria for classification as T2 capital. The amount of this T2 capital that will be recognised in the parent bank's T2 will exclude amounts recognised in CET1 under Paragraph CA-2.3.2 and amounts recognised in AT1 under Paragraph CA-2.3.3 and will be calculated as follows:

CA-2.3.5

Where capital has been issued to third parties out of a special purpose vehicle (SPV), none of this capital can be included in consolidated CET1. However, such capital can be included in consolidated AT1 or T2 and treated as if the Islamic bank licensee itself had issued the capital directly to the third parties only if it meets all the relevant entry criteria and the only asset of the SPV is its investment in the capital of the Islamic bank licensee in a form that meets or exceeds all the relevant entry criteria³ (as required by CA-2.1.5(r) for AT1 and CA-2.1.8(i) for T2). In cases where the capital has been issued to third parties through an SPV via a fully consolidated subsidiary of the Islamic bank licensee, such capital may, subject to the requirements of this Paragraph, be treated as if the subsidiary itself had issued it directly to the third parties and may be included in the Islamic bank licensee's consolidated AT1 or T2 in accordance with the treatment outlined in Paragraphs CA-2.3.3 and CA-2.3.4.

³ Assets that relate to the operation of the SPV may be excluded from this assessment if they are de minimis.

CA-2.4.2

Goodwill must be deducted in the calculation of CET1, including any goodwill included in the valuation of significant investments in the capital of banking, financial and Takaful entities that are outside the scope of regulatory consolidation. The full amount is to be deducted net of any associated deferred tax liability which would be extinguished if the goodwill becomes impaired or derecognised under IFRS or AAOIFI. The amount to be deducted in respect of mortgage servicing rights is set out in Paragraph CA-2.4.23A. Intangible assets other than goodwill and mortgage service rights are subject to transitional arrangements and are phased out as regulatory adjustments as outlined in Subparagraph CA-B.2.1(d).

CA-2.4.3

Islamic bank licensees must use the IFRS or AAOIFI definitions (as applicable) of intangible assets to determine which assets are classified as intangible and are thus required to be deducted.

CA-2.4.4

Deferred tax assets (DTAs) that rely on future profitability of the Islamic bank licensee to be realised are to be deducted in the calculation of CET1. Deferred tax assets may be netted with associated deferred tax liabilities (DTLs) only if the DTAs and DTLs relate to taxes levied by the same taxation authority and offsetting is permitted by the relevant taxation authority. Where these DTAs relate to temporary differences (e.g. allowance for credit losses) the amount to be deducted is set out in Paragraph CA-2.4.23. All other such assets, e.g. those relating to operating losses, such as the carry forward of unused tax losses, or unused tax credits, are to be deducted in full net of deferred tax liabilities as described above. The DTLs permitted to be netted against DTAs must exclude amounts that have been netted against the deduction of goodwill, intangibles and defined benefit pension assets, and must be allocated on a pro rata basis between DTAs subject to the threshold deduction treatment and DTAs that are to be deducted in full.

CA-2.4.5

An over instalment of tax or, in some jurisdictions, current year tax losses carried back to prior years may give rise to a claim or receivable from the government or local tax authority. Such amounts are typically classified as current tax assets for accounting purposes. The recovery of such a claim or receivable would not rely on the future profitability of the Islamic bank licensee and must be assigned the relevant sovereign risk weighting.

CA-2.4.6

The amount of the cash flow hedge reserve that relates to the hedging of items that are not fair valued on the balance sheet (including projected cash flows) must be derecognised in the calculation of CET1. This means that positive amounts must be deducted and negative amounts must be added back.

CA-2.4.7

This treatment specifically identifies the element of the cash flow hedge reserve that is to be derecognised for prudential purposes. It removes the element that gives rise to artificial volatility in common equity, as in this case the reserve only reflects one half of the picture (the fair value of the Shari'a compliant hedging contracts, but not the changes in fair value of the hedged future cash flow).

CA-2.4.8

Any increase in equity capital resulting from a securitisation transaction (see Chapter CA-8) must be deducted from the calculation of CET1.

CA-2.4.9

[This paragraph has been left blank.]

CA-2.4.10

Defined benefit pension fund liabilities, as included on the balance sheet, must be fully recognised in the calculation of CET1 (i.e. CET1 cannot be increased through derecognising these liabilities). For each defined benefit pension fund that is an asset on the balance sheet, the asset must be deducted in the calculation of CET1 net of any associated deferred tax liability which would be extinguished if the asset should become impaired or derecognised under the relevant accounting standards. Assets in the fund to which the Islamic bank licensee has unrestricted and unfettered access can, with supervisory approval, offset the deduction. Such offsetting assets must be given the risk weight they would receive if they were owned directly by the Islamic bank licensee.

CA-2.4.11

Paragraph CA-2.4.10 only applies to Islamic bank licensees which have subsidiaries which are located in jurisdictions where there are defined benefit pension schemes and addresses the concern that assets arising from pension funds may not be capable of being withdrawn and used for the protection of depositors and other creditors of a bank. The concern is that their only value stems from a reduction in future payments into the fund. The treatment allows for banks to reduce the deduction of the asset if they can address these concerns and show that the assets can be easily and promptly withdrawn from the fund.

CA-2.4.12

All of an Islamic bank licensee's investments in its own common shares, whether held directly or indirectly must be deducted in the calculation of CET1. In addition, any own stock which the Islamic bank licensee could be contractually obliged to purchase must be deducted in the calculation of CET1. The treatment described applies irrespective of the location of the exposure in the banking book or the trading book. In addition:

CA-2.4.13

The deduction under Paragraph CA-2.4.12 is necessary to avoid the double counting of an Islamic bank licensee's own capital. The treatment seeks to remove the double counting that arises from direct holdings, indirect holdings via index funds and potential future holdings as a result of contractual obligations to purchase own shares.

CA-2.4.14

Islamic bank licensees must deduct investments in their own AT1 in the calculation of their AT1 capital and must deduct investments in their own T2 in the calculation of their T2 capital.

CA-2.4.15

Reciprocal cross holdings of capital that are designed to artificially inflate the capital position of Islamic bank licensees will be deducted in full. Islamic bank licensees must apply a "corresponding deduction approach" to such investments in the capital of other banks and other financial entities. This means the deduction must be applied to the same component of capital for which the capital would qualify if it was issued by the Islamic bank licensee itself. The above adjustments (CA-2.4.2 to CA-2.4.15) must now be aggregated and applied to CET1 to obtain a subtotal (CET1a). This new adjusted CET1a is used for the purpose of calculating the next adjustment.

CA-2.4.16

The regulatory adjustment described in Paragraph CA-2.4.17 applies to investments in the capital of banking and financial entities that are outside the scope of regulatory consolidation and where the Islamic bank licensee does not own more than 10% of the issued common share capital of the entity. In addition:

⁴ Indirect holdings are exposures or parts of exposures that, if a direct holding loses its value, will result in a loss to the bank substantially equivalent to the loss in value of the direct holding.

⁵ If banks find it operationally burdensome to look through and monitor their exact exposure to the capital of other financial institutions as a result of their holdings of index securities, banks must risk weight all such holdings in funds at 1,250% as per the 'fall-back approach' outlined in the Basel Committee document "Capital requirements for banks' equity investments in funds - final standard" dated December 2013.

CA-2.4.17

If the total of all holdings listed in Paragraph CA-2.4.16 in aggregate exceed 10% of the Islamic bank licensee's CET1a (i.e. after applying all other regulatory adjustments from Paragraph CA-2.4.2 to Paragraph CA-2.4.15) then the amount above 10% is required to be deducted, applying a corresponding deduction approach. This means the deduction must be applied to the same component of capital for which the capital would qualify if it was issued by the Islamic bank licensee itself. Accordingly, the amount to be deducted from CET1a must be calculated as the total of all holdings which in aggregate exceed 10% of the Islamic bank licensee's CET1a (as per above) multiplied by the common equity holdings as a percentage of the total capital holdings. This would result in a CET1a deduction which corresponds to the proportion of total capital holdings held in CET1a. Similarly, the amount to be deducted from AT1 capital must be calculated as the total of all holdings which in aggregate exceed 10% of the Islamic bank licensee's CET1a (as per above) multiplied by the AT1 capital holdings as a percentage of the total capital holdings. The amount to be deducted from T2 capital must be calculated as the total of all holdings which in aggregate exceed 10% of the Islamic bank licensee's CET1a (as per above) multiplied by the T2 capital holdings as a percentage of the total capital holdings.

CA-2.4.18

See Paragraph CA-2.4.21 for further details on what to do if, under the corresponding deduction approach, an Islamic bank licensee is required to make a deduction from a particular tier of capital and it does not have enough of that tier of capital to satisfy that deduction.

CA-2.4.19

Amounts below the threshold, which are not deducted, will continue to be risk weighted. Thus, instruments in the trading book will be treated as per the market risk rules and instruments in the banking book must be treated as per Chapter CA-5. For the application of risk weighting the amount of the holdings must be allocated on a pro rata basis between those below and those above the threshold. The above adjustments (CA-2.4.16 to CA-2.4.18) must now be aggregated and applied to CET1a to obtain a new subtotal (CET1b). This new adjusted CET1b is used for the purpose of calculating the next adjustment.

CA-2.4.20

The regulatory adjustment described in Paragraph CA-2.4.21 applies to investments in the capital of banking and financial entities that are outside the scope of regulatory consolidation where the Islamic bank licensee owns more than 10% of the issued common share capital of the issuing entity or where the entity is an affiliate of the Islamic bank licensee. In addition:

⁶ Investments in entities that are outside the scope of regulatory consolidation refers to investments in entities that have not been consolidated at all or have not been consolidated in such a way as to result in their assets being included in the calculation of consolidated risk-weighted assets of the group.

⁷ If banks find it operationally burdensome to look through and monitor their exact exposure to the capital of other financial institutions as a result of their holdings of index securities, the CBB may permit banks, subject to prior CBB approval, to use a conservative estimate.

CA-2.4.21

All investments in Paragraph CA-2.4.20 that are not common shares must be fully deducted following a corresponding deduction approach. This means the deduction must be applied to the same tier of capital for which the capital would qualify if it was issued by the Islamic bank licensee itself. If the Islamic bank licensee is required to make a deduction from a particular tier of capital and it does not have enough of that tier of capital to satisfy that deduction, the shortfall will be deducted from the next higher tier of capital (e.g. if an Islamic bank licensee does not have enough AT1 capital to satisfy a particular deduction, the shortfall will be deducted from CET1c).

CA-2.4.22

Investments in Paragraph CA-2.4.20 that are common shares are subject to the threshold treatment described in Paragraph CA-2.4.23. The above adjustments (CA-2.4.20 to CA-2.4.21) must be aggregated and applied to CET1b to obtain a new subtotal (CET1c). This new adjusted CET1c is used for the purpose of calculating the next adjustment.

CA-2.4.23

If the total of all common equity holdings listed in Paragraph CA-2.4.20 in aggregate exceeds 10% of the Islamic bank licensee's CET1c, then the amount above 10% is required to be deducted from CET1c (see Appendices CA-11 and CA-12 for examples). After this deduction, the Islamic bank licensee must deduct the amount by which each of items b) and c) in Paragraph CA-2.4.23A individually exceeds 10% of its CET1c. After these individual deductions, the aggregate of the three items below which exceeds 15% of its CET1c (calculated prior to the deduction of these items but after application of all other regulatory adjustments to CET1 applied in Paragraphs CA-2.4.2 to CA-2.4.21) must be deducted from CET1c. The adjustments in this Paragraph are applied to CET1c to obtain a new subtotal (CET1d). This new adjusted CET1d is used for calculating the consolidated CAR and the applicable caps on AT1 and T2. The items included in the 15% aggregate limit are subject to full disclosure.

CA-2.4.23A

As of 1 January 2020, the calculation of the 15% limit will be subject to the following treatment: the sum of the three items below that remains recognised after the application of all regulatory adjustments must not exceed 15% of CET1d (See Appendix CA-3 for an example):

CA-2.4.24

The amount of the three above items that are not deducted in the calculation of CET1d is risk weighted at 250% (see Paragraph CA-3.2.26).

CA-2.4.25

The following items receive the following risk weights:

CA-2.4.26

For Subparagraphs CA-2.4.25 (c) and (d), amounts below the materiality thresholds and large exposure limits continue to be risk weighted in accordance with Chapter CA-3. Where the remaining holdings are made up of holdings carrying different risk weights, the application of the risk weighting must be allocated on a pro rata basis for those exposures that are not subject to the 800% risk weight. Appendix CA-10 gives an example of the way to calculate the risk weighted assets and the effect of the limits outlined in Subparagraphs CA-2.4.25 (c) and (d).

CA-2A.2.4

Where an Islamic bank licensee fails to meet the required level of capital conservation buffer, it must prepare a Capital Conservation Plan (hereinafter referred to as "Plan") clearly outlining the information mentioned in this Paragraph. The Islamic bank licensee must submit this Plan to the CBB within one week of becoming aware of the shortfall (see also CA-1.2.2). The Islamic bank licensee must already have prepared such a Plan on a contingency basis. The Plan must include the following:

CA-2A.2.5

The CBB shall review the Plan submitted by the Islamic bank licensee and shall approve it provided it considers that the Plan provides a reasonable basis for conserving or raising sufficient capital that will enable the Islamic bank licensee to meet the buffer requirements within a period acceptable to the CBB. While reviewing the Plan, the CBB will also evaluate whether the Islamic bank licensee has deliberately reduced its CET1 so as to operate in the buffer range (i.e. below the capital conservation buffer requirement) in order to reduce its cost of capital for competitive purposes.

CA-2A.2.6

If the Plan is not approved by the CBB, it may take one or more of the following steps, inter alia, as deemed necessary:

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.

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: