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  • CM-1.4 CM-1.4 Credit Risk Measurement and Monitoring

    • CM-1.4.1

      Islamic bank licensees must have methodologies that enable them to quantify the risk involved in exposures to individual obligors or counterparties. Islamic bank licensees must also be able to analyse credit risk at the product and portfolio level, in order to identify any particular sensitivities or concentrations. The measurement of credit risk must take account of the following:

      (a) The specific nature of the credit and its contractual and financial conditions (maturity, reference rate, etc.);
      (b) The exposure profile until maturity in relation to potential market movements;
      (c) The existence of collateral or guarantees; and
      (d) The potential for default based on the internal risk rating.

      The analysis of credit risk data must be undertaken at an appropriate frequency, with the results reviewed against relevant limits.

      Added: June 2022

    • CM-1.4.2

      Islamic bank licensees must use measurement techniques that are appropriate to the complexity and level of the risks involved in their activities, based on robust data and subject to periodic validation.

      Added: June 2022

    • CM-1.4.3

      Islamic bank licensees must monitor actual exposures against established limits. It is important that licensees have an MIS in place to ensure that exposures approaching risk limits are brought to the attention of senior management. All exposures must be included in a risk limit measurement system. Islamic bank licensee’s information system must be able to aggregate credit exposures to individual obligors and counterparties and report on exceptions to credit risk limits in a meaningful way and on a timely basis.

      Added: June 2022

    • CM-1.4.4

      Islamic bank licensees must take into consideration potential future changes in economic conditions when assessing individual credits and their credit portfolios and must assess their credit risk exposures under stressful conditions.

      Added: June 2022

    • CM-1.4.5

      An important element of sound credit risk management involves discussing what could potentially go wrong with individual credits and within the various credit portfolios and factoring this information into the analysis of the adequacy of capital and provisions. The supervisory guidance on accounting for expected credit losses has been provided in Section CM-1.8.

      Added: June 2022

    • Credit Rating /Scoring

      • CM-1.4.6

        Islamic bank licensees must have in place a Board approved policy to develop, review and implement an internal risk rating system. Such a system must be able to assign a credit risk rating or scoring to obligors that accurately reflects the obligors’ risk profile and likelihood of loss.

        Added: June 2022

      • CM-1.4.7

        Islamic bank licensees must assign risk ratings or scoring in a consistent manner to enable the licensee to classify obligors by risk ratings or scoring and have a clearer understanding of the overall risk profile of its portfolio. The licensee’s credit risk policy must define the various risk grades of its rating system. Criteria for assigning risk grades and the circumstances under which deviations from the criteria are permitted must be set. The credit risk policy must also define the roles of different parties involved in the rating process.

        Added: June 2022

      • CM-1.4.8

        The credit risk rating/scoring process must appropriately group credit exposures on the basis of shared credit risk characteristics.

        Added: June 2022

      • CM-1.4.9

        Islamic bank licensees’ credit exposures must be grouped according to shared credit risk characteristics, so that changes in the level of credit risk respond to the impact of changing conditions on a common range of credit risk drivers. This includes considering the effect on the group’s credit risk in response to changes in forward-looking information, including macroeconomic factors. The licensee must review the appropriateness of the grouping implemented upon initial recognition based on similar credit risk characteristics, at regular intervals, at least annually, to ensure that the relevant characteristics and their impact on the level of credit risk of the different groupings have not changed over time.

        Added: June 2022

      • CM-1.4.10

        Islamic bank licensees must validate their risk rating or scoring system and ascertain its applicability to their portfolio prior to implementation. An external independent party, other than the external auditor, with necessary expertise in model validation, must conduct the validation of the risk rating/scoring and ECL models every three years and upon development of the model, and also when there are material changes to the portfolio, rating/scoring model or model parameters (See also Paragraph CM-1.2.22 (c)).

        Added: June 2022

      • CM-1.4.11

        Islamic bank licensees that use a judgmental rating or scoring system must ensure that each rating is unique, well-defined and distinct from other ratings in the rating scale. The relevant risk factors and weights employed in the rating/scoring methodology must be appropriate for the risk profile of the obligors in different market segments, such as corporations, small and medium-sized enterprises (‘SMEs’), and financial institutions.

        Added: June 2022

      • CM-1.4.12

        Risk ratings must be assigned at the inception of financing and updated at least on an annual basis. Additionally, Islamic bank licensee must review the ratings or scoring as and when adverse events occur. Risk ratings or risk scores assigned to various obligors must be reviewed by the licensee’s personnel that are independent of those involved in financing origination. As part of its portfolio monitoring, the licensee must generate reports on credit exposures by risk rating/scores. Trend and migration analysis between risk ratings /scores must also be conducted to detect changes in the credit quality of the portfolio.

        Added: June 2022

      • CM-1.4.13

        The licensee may establish target limits for risk grades to highlight concentration in particular rating bands. The analysis of the portfolio by risk ratings is meaningful only when the licensee’s rating or scoring system is able to consistently assign similar ratings or scores to obligors with similar risk profiles.

        Added: June 2022

      • CM-1.4.14

        After the credit facility has been granted, its performance must be monitored at regular intervals. This includes an appropriate periodic review of financial statements, a reassessment of collateral and update of appraisals, and attentive monitoring of conditions in the obligor's industry. Credit supervision constitutes the first line of detection of difficulties and provides the licensee with an opportunity to address problems before losses are sustained. The credit review must ensure that the credit files are complete and that all credit approvals and other necessary documents relating to the obligor are available.

        Added: June 2022

      • CM-1.4.15

        Islamic bank licensees must perform regular credit reviews. The purpose of a credit review is to verify that credits are granted in accordance with the licensee’s credit risk policy and to provide an independent judgment of asset quality. Islamic bank licensees must conduct credit reviews with updated information on the obligor’s financial and business conditions, as well as the conduct of the account. Exceptions noted must be evaluated for impact on the obligor’s creditworthiness.

        Added: June 2022

      • CM-1.4.16

        Credit reviews must also be conducted on a consolidated group basis to factor in the business connections among connected entities. The performance of the underlying assets in the case of securitisation exposures must also be included in the credit reviews.

        Added: June 2022

      • CM-1.4.17

        Credit reviews must be performed and documented at least once a year other than for facilities subject to collective assessments. For Stage 2 and 3 accounts (See Paragraph CM-1.8.23), however, more frequent reviews must be conducted. Procedures must also be instituted to ensure that reviews are conducted at the appropriate frequency. A process to approve deferment of credit reviews must also be put in place. For consumer credits, annual credit reviews of individual obligors are only needed if significant and a portfolio analysis does not identify credit risk related issues or problems. However, credit exceptions and deterioration must be monitored and reported.

        Added: June 2022

    • Credit risk stress testing

      • CM-1.4.18

        Stress testing must involve identifying possible events or future changes in economic and other conditions that could have unfavourable effects on the Islamic bank licensee's credit exposures and assessing its ability to withstand such changes. Three areas that the licensee could usefully examine are: (i) economic or industry downturns; (ii) market risk events; and (iii) liquidity conditions. Stress testing can range from relatively simple alterations in assumptions about one or more financial, structural or economic variables, to the use of highly sophisticated financial models.

        Added: June 2022

      • CM-1.4.19

        Stress tests are to be performed by adjusting the parameters and then recalculating credit losses, for example:

        (a) Unfavourable changes (increases/decreases, depending on portfolio composition) in the underlying profit rate by a certain number of basis points; and
        (b) Unfavourable changes (increases/decreases, depending on portfolio composition) in crucial exchange rates by a certain percentage.
        Added: June 2022

      • CM-1.4.20

        In undertaking credit risk stress tests, licensees should consider counterparty-based and credit facility-based risk factors and scenarios that help estimate credit losses after modelling a change in probability of default (‘PD’) and/or loss given default (‘LGD’) or exposure at default (‘EAD’). Stress testing programmes should consider:

        (a) The inclusion of the licensee’s individual credit portfolio composition and compile a list of the credit products in use;
        (b) Identify the decisive risk factors for each individual credit product and develop a basis for prioritising the factors by relevance and to group those risk factors which influence each other strongly under normal conditions or in crisis situations for the development of stress tests;
        (c) Analyse the prevailing social, economic, and political conditions and filter as many potential crisis situations as possible and relevant;
        (d) Use of in-house as well as external expertise, as appropriate, and ensure that the stress tests attain the necessary level acceptance.
        Added: June 2022

      • CM-1.4.21

        The approaches towards modelling stress tests include the following elements considered individually and on a combined basis as appropriate and with varying severity:

        (a) Downgrading all obligors by one rating class;
        (b) Increasing default probabilities by a certain percentage;
        (c) Increasing LGD by a certain percentage;
        (d) Increasing EAD by a certain percentage for variable credit products (justification: customers are likely to utilize credit lines more heavily in crisis situations, for example);
        (e) Assumption of negative credit spread developments for Sukuks;
        (f) Modelling of input factors (e.g. balance sheet indicators).
        Added: June 2022

      • CM-1.4.22

        Additionally, the impact of macroeconomic risk factors such as fluctuations in profit rates and/or exchange rates etc. on the following illustrative general conditions may be considered:

        (a) Stress tests for specific industries or regions;
        (b) Downgrading all obligors in one or more crisis-affected industries; and
        (c) Downgrading all obligors in one or more crisis-affected regions.
        Added: June 2022

      • CM-1.4.23

        If the licensee uses risk models (such as credit portfolio models or credit pricing models), it is necessary to perform stress tests which show whether the assumptions underlying the risk models will also be fulfilled in crisis situations. Only then will the models be able to provide the appropriate guidance in crisis situations.

        Added: June 2022

      • CM-1.4.24

        Islamic bank licensees should also examine political risk factors when significant parts of the credit portfolio consist of obligors from politically unstable countries. Due to the complex interrelationships involved, however, developing plausible stress tests for political risk factors involves far more effort than designing tests for macroeconomic risk factors. It is, therefore, advisable to call in specialists to develop stress tests for political risk factors in order to assess the relevant effects on financial and macroeconomic conditions.

        Added: June 2022

      • CM-1.4.25

        The output of the stress tests must be reviewed periodically by senior management and appropriate action taken in cases where the results exceed agreed tolerances. The output must also be incorporated into the process for assigning and updating policy and limits.

        Added: June 2022

      • CM-1.4.26

        Islamic bank licensees must attempt to identify the types of situations, such as economic downturns, both in the whole economy or in particular sectors, higher than expected levels of delinquencies and defaults, or the combinations of credit and market events that could produce substantial losses or liquidity problems.

        Added: June 2022