Credit risk is generally defined as the potential that a counterparty fails to meet its obligations in accordance with agreed terms. This definition is applicable to Islamic bank licensees managing the financing exposures of receivables and leases (for example, Murabahah, Diminishing Musharakah and Ijarah) and working capital financing transactions/projects (for example, Salam, Istisna` or Mudarabah¹). Islamic bank licensees manage credit risks inherent in their financings and investment portfolios relating to default, downgrading and concentration. Credit risk includes the risk arising in the settlement and clearing of transactions.

¹ In cases where Mudarabah is used in project finance, a licensee advances funds to a customer who acts as Mudarib in a construction contract for a third-party customer (ultimate customer). The ultimate customer, who has no direct or contractual relationship with the licensee, will make progress payments to the Mudarib who in turn makes payment to the licensee. The role of the licensee is to provide bridging finance on a profit-sharing basis to the Mudarib pending its receipt of the progress payments from the ultimate customer. The licensee is exposed to credit risk on the amounts advanced to the Mudarib.