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ST-2.2.2

Highlighted below are some examples of risk factors that may be relevant to the Islamic bank licensees:

(a) Credit risk characterised by an increase in default probabilities (e.g. the rise in delinquencies and charge-offs); a decline in recovery rates or in the value of supporting collateral; a rating migration of counterparties, issuers or credit protection providers; and worsening of credit spreads. Banks should be aware of the major drivers of repayment ability (such as economic downturns and significant market shocks) that will affect all classes of counterparties or credits;
(b) Concentration risk in terms of the large chunks of exposures to individual counterparties, products / instruments, industries, market sectors, countries or regions which are driven by the same risk factors. Banks should also assess the contagion effects and possible linkages (and the potential changes in such interrelationships, both over time and in times of stress) which may lead to disproportionate increase in risk exposure;
(c) Rate of return risk arising from parallel shifts or twists in the yield curve and the increase in basis risk (i.e. changes in relationships between key market rates);
(d) Market or price risk arising from adverse changes in the price or fair value of assets (e.g. currencies, equities, commodities or other financial instruments) and their impact on relevant portfolios and markets;
(e) Liquidity risk as a result of the tightening of financing lines, tightening of secured or unsecured funding markets, market liquidity for certain asset classes, the triggering of obligations to provide additional collateral or margin under financing agreements or unexpected increase in drawdown of financing facilities and redemption of investment accounts;
(f) Operational risk (including legal risk) caused by various factors such as internal or external fraud, system failure and security risks (e.g. in respect of transactional e-banking services), and litigation cases that may lead to material monetary loss or reputational impact on the bank concerned if the outcome is not in its favour;
(g) Strategic risk resulting from events or changes in the environment that could adversely alter the original assumptions made in the strategic plan and any potential threats to bank's business, both financially and non-financially;
(h) Reputational risk stress testing in terms of identifying scenarios (may be due to misconduct, financial crime, market view about the stability of the bank) which will have a negative reputational impact and in turn result in increased credit risk (e.g. run on the bank), liquidity risk (tightened access to funding markets) or market risk ( drop in equity value).
(i) Product-specific risks such as prepayment risk. Other potential risks may also arise from abnormal market movements and their impact on contingent credit exposures and complex products (e.g. structured products with embedded multiple risks);
(j) System-wide interactions and feedback effects that reflect the impact of likely behavioural responses of other market participants and their counterparties on the broader market in times of stress, and how that impact will feed back to the bank's own positions;
(k) Macroeconomic factors (e.g. gross domestic product ('GDP') growth, change in property prices, unemployment rate and inflation or deflation rate) and their impact on other risk factors; and
(l) Political and economic factors pertaining to industries, regions and markets.
July 2018