identifying significant activities and measuring risks inherent in iifs risk-based supervision in...

Identifying Significant Activities andMeasuring Risks Inherent in IIFS

Risk-based Supervision in Institutions offering Islamic Financial Services (IIFS)

2-5 February 2015

Kuwait city, Kuwait

Abdullah Haron

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Agenda

• Defining Significant Activities in IIFS

• Identifying Types of Risks Inherent in IIFS

• Assessing the Criteria

Significant Activities in IIFS

Adapted from IAIS Framework for Supervisory Review Assessment3

Credit Market OperationalRegulatory Compliance StrategySignificant Business or Process

Inherent Risk

Risk Matrix for IIFS

Retail financing?Treasury?Real estate investment?AML?

Significant Activities in IIFS

What is the (material) to the achievement of IIFS’ business strategies? Some questions to consider:

What is the activities that may result in risk of losses to IIFS where it will not meet its objectives?

What is the line of business, process or subsidiary’s potential impact on earnings, solvency, liquidity, funding, capital, reputation, internal expertise and capacity of the IIFS, brand value, or system of internal controls?• Small activities but are profitable may raise flag

• Significant activities can be a subset of all activities• IIFS’ significant activities may differ from one to another• Continuous assessments both from macro and micro economic

perspective and how they affect the IIFS

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Significant Activities in IIFS (cont’d)

Material• Real Estate• AML

In Between• ?• ?

Not Material• Treasury• Outsourcing recruitment

High

Low

Activities12345678910111213

• What is the expected impact on the IIFS’s customers/depositors/IAH?• What is the likely impact on the IIFS’s reputation?• Would it have a material impact on the IIFS’s risk profile?• How long would it take and what costs would be involved?

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What are examples of significant activities in IIFS? Business line

Process

Subsidiary

• What would be the criteria?

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Various sources: Organization chart Business plan Discussion

• Senior management• Shari`ah compliant oversight

• Follow lines of accountability and responsibility• Understand the inherent risks specific to the IIFS and how they are

managed• A lot of judgment is required to agree on “significant activities”

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Criteria of Significance Qualitative

• Strategic importance to the industry or jurisdiction• Reputation of Shari`ah non-compliance

Quantitative• Percentage of assets or capital• Impacts of tainted income to IAH• Loss absorbency of PSIA

• What is other potential qualitative and quantitative criteria for IIFS?• Which criteria signify materiality?• How many significant activities do you need?• How detail do you want to go?

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Types of Risks Inherent in IIFS


Credit Market OperationalRegulatory Compliance StrategySignificant Business or Process

Inherent Risk

Risk Matrix for IIFS

RatingHigh?Above average?Moderate?Low?

Risks Inherent in IIFS

Definition Probability of material losses due to exposure to, and uncertainty

arising from, current and potential future events A material loss is one that could impair the adequacy of capital –

potential loss to depositors, investors and other creditors Inherent risk is intrinsic to a “Significant Activity” and can change as a

result of the developments

• Why shouldn’t we assess risk management when assessing inherent risk?

• What is the purpose of assessing inherent risk?

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Risks Inherent in IIFS (cont’d)

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Instruments

Salam and Parallel Salam

Murabahah and Murabahah for Purchase Orderer

• Shari`ah governance: to ensure Shari`ah rules and principles are complied at all times

• Capital and risk management: to ensure the soundness of the institutions

• Transparency and market discipline: to ensure the protection on the rights of the relevant stakeholders

PRUDENTIAL REGULATIONCharacter Types of Risk

Istisna` and Parallel Istisna`

Ijarah and Ijarah Muntahia Bittamleek

Musharakah and Diminishing Musharakah

Mudarabah

Sale or purchase of an asset

Sale of the usufruct

Profit (and /or loss) sharing

Market , Credit and Operational Risks

Specific Risk – Displaced Commercial

Market, Credit, Operational and Business Risks

Specific Risk – Fiduciary

Risk Identification


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DisplacedCommercial

Risk

Risks in Banking Industry Specific Risks in IIFS

Credit Risk

Market Risk

OperationalRisk

Equity Investment

Risk

Rate of ReturnRisk

Sharī`ah non-Compliance

RiskFiduciary

Risk

Liquidity


Category Credit (including equity investment) Market Operational Rate of return (displaced commercial risk) Liquidity

• Why shouldn’t we include reputational risk?• Depending on the jurisdiction, the list of risks can be made granular

for a more comprehensive understanding of risks (e.g. credit risks can be sub-divided into credit and equity investment) Clear and precise definition is important

• Only relevant and significant risks should be identified. Will the assessment of “net risk” change?

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Criteria to assign rating Obtain a sound understanding of the activity as undertaken by IIFS Assess the activity before and without considering the quality of the

risk management process and control• Size does not matter• Probability does not change

Factors that could increase or decrease the rating Nature of market segment, extent of concentration, distribution

channel, operational complexity, regulations

• Size of the significant activity do not have any impact in inherent risk ratings

• Inherent risk of a particular activity (e.g. real estate investment) is the same for all IIFS in the same jurisdiction

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Discussion What is the primary inherent risks of these products?

• Mortgage financing• Commodity Murabahah

Is the credit risk inherent in the following example the same?• Mortgage financing of USD1 million• Mortgage financing of USD50 million

Is the liquidity risk inherent in the following example the same?• PSIA of USD1 million• Commodity Murabahah of USD1 million

• The assessment of risks inherent in IIFS should be dynamic, forward looking, continuous and systematic due to the nature of PSIA

• Challenges: definitions of each inherent risk, mixing inherent risk and oversight assessment, consistency in the starting point of different asset class

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Definition:Credit risk is defined as the exposure to thelikelihood that a counterparty will fail to meet Its obligations in accordance with agreed terms

Sources:Exposure to potential loss in:1. Receivables and leases (e.g. Murabahah, Diminishing Musharakah and Ijarah) 2. Working capital financing transactions (e.g.Salam, Istisnaòr Mudarabah)3. Non-traded equity instruments, (such as those based on Mudarabah and Musharakah contracts, which are held for investment purposes and not for trading)

Principle 2.1: IIFS shall have in place a strategy forfinancing, using various instruments in compliance with Sharīàh, whereby it recognises the potential credit Exposures that may arise at differentstages of the various financing agreements.

Principle 2.2: IIFS shall carry out a due diligence review in respect of counterparties prior to deciding on the choice of an appropriate Islamic financing instrument.

Principle 2.3: IIFS shall have in place appropriatemethodologies for measuring and reporting the credit risk exposures arising under each Islamicfinancing instrument.

Principle 2.4: IIFS shall have in place Sharīàh-compliant credit risk mitigating techniquesappropriate for each Islamic financing instrument.

IFSB: Credit Risk Management Principles

Credit risk principles also applicable to Credit risks associated with securitisation

and investment activities(e.g. Investment certificate or sukuk)

Credit Risk

Sources:Risks associated with Muḍārabah or Mushārakah partner, business activity and operations

IFSB: Equity Investment Risk Principles

Principle 3.1: IIFS shall have in place appropriate strategies, risk management and reporting processes in respect of the risk characteristics of equity investments, including Muḍārabah and Mushārakah investments.

Principle 3.2: IIFS shall ensure that their valuation methodologies are appropriate and consistent, and shall assess the potential impacts of their methods on profit calculations and allocations. The methods shall be mutually agreed between the IIFS and the Muḍārib and/or Mushārakah partners.

Principle 3.3: IIFS shall define and establish the exit strategies in respect of their equity investment activities, including extension and redemption conditions for Muḍārabah and Mushārakah investments, subject to the approval of the institution’s Sharī`ah Board.

Definition:Equity investment risk broadly defined as the risk arising from entering into a partnership for the purpose of undertaking or participating in a particular financing or general business activity as described in the contract, and in which the provider of finance shares in the business risk.

Profile:• Distinct difference between Muḍārabah

and Mushārakah financings is in terms of IIFSs’ involvement in investment

• Due diligence for fiduciary responsibility• Legal and regulatory environment (Tariffs,

quotas, taxation or subsidies etc)• Lack of reliable information

Equity Investment Risk

IFSB: Market Risk Principle

Principle 4.1: IIFS shall have in place an appropriate framework for market risk management (including reporting) in respect of all assets held, including those that do not have a ready market and/or are exposed to high price volatility.

Definition:Market risk normally refer to the potential impact of adverse price movements such as benchmark rates, foreign exchange (FX) rates, equity prices and commodity prices, on the economic value of an asset

Sources:1. Fluctuations in values in: Tradable and marketable instruments (including Sukuk) Investments in lease assets, Off balance sheet individual portfolios (for example, restricted investment accounts).

2. The risk arise from the current and future Volatility of market values of: Specific assets ( e.g. commodity price of Salam asset, market value of a sukūk, and market value of Murābahah assets purchased to be delivered over a specific period) and Foreign exchange rates

Market Risk

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• Level of acceptable market risk appetite

• Types of risk taking activities• Target markets • Reviewed periodically and disclosed to

fund providers

Principles 4.1: Market Risk Management

Develop a market risk strategy

Quantify market risk exposures and assessExposure to the probability of future losses

Valuation of assets where no direct prices are not available

Risk appetite for tradable assets and Adequately supported by capital

Where available valuation methodologies are deficient: a) assess the need to allocate

funds to cover risks resulting from illiquidity; b) establish a contractual agreement withCounterparty specifying the methods to

be used in valuing the assets

Same risk management policies and Procedures to assets held as RIAH

Sound and comprehensive market risk management Process & information system

• Conceptual framework for MR• Guidelines governing risk taking in

different portfolios of RIAH and their market risk limits

• Appropriate frameworks for pricing, valuation and income recognition

• Strong MIS for controlling, monitoring and reporting market risk exposure and performance to appropriate levels of senior management

Market Risk (cont’d)

IFSB: Operational Risk Principles

Principle 7.1: IIFS shall have in place adequate systems and controls, including Sharīàh Board/ Advisor, to ensure compliance with Sharīàh rules and principles.

Principle 7.2: IIFS shall have in place appropriate mechanisms to safeguard the interests of all fund providers. Where IAH funds are comingled with IIFSs’ own funds, IIFS shall ensure that the bases for asset, revenue, expense and profit allocations are established, applied and reported in a manner consistent with IIFSs’ fiduciary responsibilities.

Definition:Risk of loss resulting from inadequate or failed internal process, people and systems or from external events. IIFS shall also incorporate possible causes of loss resulting from Sharīàh non-compliance and the failure in their fiduciary responsibilities.

Sharīàh non-compliance

Fiduciary responsibilities

Fund providers’ withdrawals,

loss of income,Voiding of contracts etc

Leading to diminished Reputation or the limitation of business opportunities

These risks expose IIFS

Operational Risk

Risk Matrix of an IIFS


Inherent Risk

Rating Direction Time FrameEarningCapitalLiquidityComposite Risk

ImportanceSignificant Business or ProcessGovernance and Oversight Function

Net Risk Direction of Risk

When assigning composite rating, - It is not simply a numerical average- Need to reflect inter-relationship and impact of components for

example, potential of loss absorbency of PSIA dan DCR- Need to ensure comparability and relative strength

In assessing earnings of an IIFS Identification of earning components

• Net profit income• Other income• Provisions of expense• Trading (e.g. real estate, commodity murabahah)• Overhead, Zakat and tax• Tainted income

Quality of those earnings Earning analysis

• Trend, peer review (within the Islamic financial services industry and overall banking industry), growth

Rating earnings

Earning

In assessing earnings of an IIFS Is the quantity and quality of earnings adequate or

inadequate? How much is the tainted income? WHY? Did the IIFS achieve return-on-asset above peer

performance? WHY? Did the IIFS meet or exceed the budget for the year?

WHY? Did the IIFS achieve a higher or lower performance

from the previous year? WHY? Did the IIFS use PER or IRR in boosting its earnings?

Earning (cont’d)

A strong rating on earnings indicates that earnings are more than sufficient to support operations, maintain adequate capital and allowance levels after consideration is given to asset quality, growth and other factors affecting quality, quantity and trend of earnings.

Given that IAHs share the profit and bear the loss of the IIFS, supervisors need to assess the profit payouts to IAHs in relation to displaced commercial risk.

Earning (cont’d)

In assessing capital of an IIFS Sources of capital Tier 1 and Tier 2 capital components Evaluation of capital

• Risks• Additional ratios• Capital planning• Rating

Capital

Ability to maintain satisfactory source of capital Earnings retention

• The first line of defense against losses• Good earnings are a critical factor in IIFS’s ability to

raise capital from external sources Asset redistribution/reallocation

• Trading higher risk assets for lower risk ones (e.g., swapping financing for government securities)

Issuance• Ability to raise capital (access to capital markets/

investors) especially under stress

Capital (cont’d)

Components of Tier 1 Capital Common Stock

• Par value, or face value, of stock Surplus

• Price over par value when the stock is sold Undivided Profits/Retained Earnings

• Past period earnings that have not paid out in dividends Less: Intangible assets (e.g. goodwill, patents, copyrights),

certain investments, tax assets etc.

Capital (cont’d)

Components of Tier 2 Capital Loan Loss Reserves

• limited to 1.25% of risk-weighted assets

Term Subordinated Debt• Debt that is junior to other debt

Limit: Tier 2 capital may not exceed 100% of Tier 1 capital

Capital (cont’d)

Evaluation of Capital: Capital Ratios Risk Based:

• Tier 1 Capital to Risk Weighted Assets• Total Capital to Risk Weighted Assets• Tier 1 Common Capital to Risk Weighted Assets

Leverage:• Tier 1 Capital to Average Total Assets• Tier 1 Common Capital to Average Total Assets

Accounting:• Stockholders’ Equity to Total Assets• Stockholders’ Equity to Average Total Assets

Capital (cont’d)

Minimum Requirement for Capital Ratio Tier 1 Risk Based Capital Ratio = 6% Total Risk Based Capital Ratio = 8% Tier 1 Leverage Ratio = 4%

Capital (cont’d)

Evaluating Capital in IIFS Asset Quality: Credit and Market Risks Earnings: Market, Operational, and Credit Risks Liquidity: Liquidity Risk (including withdrawal risk) Other Risks: Legal and Reputational Risk Capital Planning

• Capital sufficient in relation to current risk and strategic initiatives; All business lines identified; Contingent liabilities reasonable; Capital requirements integrated into dividend policy; Internal qualitative and quantitative assessments of capital

Capital (cont’d)

A strong rating on capital indicates a strong capital level relative to the IIFS’s risk profile (RBC ratios significantly above minimum requirements)

Although PSIA is considered as quasi-equity in IIFS, it cannot be considered as capital because PSIA can withdraw its investment anytime with certain conditions. Hence, it is not considered as a stable equity.

Capital (cont’d)

IFSB: Liquidity Risk Principles

Principle 5.1: IIFS shall have in place a liquidity management framework (including reporting) taking into account separately and on an overall basis their liquidity exposures in respect of each category of current accounts, unrestricted and restricted investment accounts.

Principle 5.2: IIFS shall assume liquidity risk commensurate with their ability to have sufficient recourse to Sharī`ah-compliant funds to mitigate such risk.

Definition:Liquidity risk is the potential loss to IIFS arising from their inability either to meet their obligations or to fund increases in assets as they fall due without incurring unacceptable costs or losses

Sources:Major type of funds:1. Current account holders

• Guaranteed• Repayment at any time

2. Unrestricted Investment account holders (UIAH)• Share profit and bear losses from• Investment on their behalf

UIAH may also Withdraw their fund • if return lower than expected rate of return,• concern about financial condition of the IIFS,

and if IIFS do not comply with Shari’ah rule

Liquidity Risk

In assessing liquidity of an IIFS, check if any Deterioration in asset quality Excessive borrowings Changes in fund providers Decreased size of individual transactions Difficulty obtaining long-term funding Increased Loan to Deposit ratios Rapid decrease in deposits or withdrawal of PSIA Large rise in asset sales Negative press Concentrations

Liquidity Risk (cont’d)

General components of liquidity risk management Risk Measurement & Controls

• Limit Structure• Gap Analysis

Contingency Funding Plan• Scenario Analysis

Management Process Management Information Systems (MIS)


LMP

BOD/ SM Oversight

Monitoring

Reporting

Shariah Support

Crisis Management

Contingency

Qualitative Factors

skills in treasury management and Public Relations

general ability of the management

IIFSs’ reputation in the market

willingness and ability of the head office/ parent to provide liquidity in the case of a branch or subsidiary:

willingness and ability of shareholders to provide additional capital

Quality of MIS

Quantitative Factors

Extent of diversity and

sources of funds

concentration of the funding base

reliance on marketable assets

availability of standby lines of external funding

Liquidity Management Policy (LMP)Liquidity Management Policies should

incorporate both Qualitative and Quantitative factors:

Operational Considerations

Principles 5.1: Liquidity Management Framework


Known Cash flows

• Maturities and the amounts known in advance. • Receivables from Murabahah, Ijarah, IMB receivables and

Diminishing Musharakah

Conditional but

predictable Cash flows

• (Salam and Istisna) –conditionality based on the agreed terms and conditions over an agreed period

Conditional and

unpredictable Cash flows

• Investment in Musharakah for open-ended period with exit strategy may be assessed periodically.

• The redemption of invested capital and possible level of ROI is conditional upon the performance of the activities.

Mostly, IIFS depend on Short Term funding, which can “disappear” too rapidly in case of liquidity crunch. IIFS…Assume funds repaid at maturity and No rollover.

Conventional banks usually like to raise Long Term debt, but IIFS face hurdles.

Result: Asset-Liability mismatch and resulting liquidity problem

Th

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Typ

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Measuring and Monitoring Liquidity

Nature

Of IIFS’

Balance

Sheet

Principles 5.1: Liquidity Management Framework


• Holdings of tradable high quality liquid assets • Profile and the degree of liquidity of other assets • Assessment of Shariah-compliant and available

funding products in the market;• Possible agreements with other IIFS or conventional • institutions on an interest-free basis - for accessing • temporary funding or sale and leaseback • arrangements for longer term funding

• Possible liquidity arrangements with the central bank (on an interest-free basis)

• Establishment of a crisis management team or personnel responsible for taking actions at different stages of the liquidity crisis

• Notification procedures for communication with IIFS’s head office and/or supervisory authorities

LCP- Inclusion of Following factors and Defining Possible action points at each stage:

Emergency Measures

LCP- Stage-3

Liquidate Assets

Liquidation procedures

LCP- Stage-2

Identification of liquidity gap

LCP- Stage-I

Or Situation acting as a Triggering Event, Withdrawals don’t follow predictable

pattern e.g. Institutional Rating

Downgrade

or Investmentsin an orderly manner

to meet such a liquidity gap or situationIn case all previous

measures fail to meet the liquidity gap adequately

Principles 5.2: Liquidity Risk Mitigation-Liquidity Contingency Plan (LCP)


Basel III: Liquidity Coverage Ratio The objective is to promote the short-term resilience

of the liquidity risk profile of IIFS by ensuring that they have sufficient high-quality liquid assets to survive a significant stress scenario lasting 30 calendar days

Stock of High Quality Unencumbered Liquid Assets > 100%

Net cash outflows over 30 days under a Stress Scenario


Basel III: Liquidity Coverage Ratio


Basel III: Net Stable Funding Ratio (NSFR) The objective is to promote resilience over a longer

time horizon by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing basis. The NSFR has a time horizon of one year and has been developed to capture structural issues to provide a sustainable maturity structure of assets and liabilities

Available Amount of One-Year Stable Funding (Sources)>100%

Required Amount of One-Year Stable Funding (Uses)


Basel III: Net Stable Funding Ratio


Other potential ratios that maybe applicable to IIFS Illiquidity asset - long-term assets (defined as

maturing beyond a specified time period) as a percent of total assets• To better gauge the potential for assets to be used

as sources of liquidity to meet uncertain future cash needs

Relative stability or volatility of sources of fundingTo assess the relative stability or volatility of

liabilities or PSIA as sources of funds through an assessment of the maturity of liabilities and their ability to be ‘‘rolled-over’’ or renewed under both normal business and adverse circumstances


A strong rating on liquidity indicates a sufficient volume of liquid assets and/or ready and easy access to external sources of liquidity, on favorable terms.

The challenge to IIFS is readily available short-term Shari`ah compliant assets. Insufficient volume may result in IIFS maybe at disadvantage compared to their peers in conventional institutions.


IFSB: Rate of Return Risk Principles

Principle 6.1: IIFS shall establish a comprehensive risk management and reporting process to assess the potential impacts of market factors affecting rates of return on assets in comparison with the expected rates of return for investment account holders (IAH).

Principle 6.2: IIFS shall have in place an appropriate framework for managing displaced commercial risk, where applicable.

Definition:The possible impact on the net income of the IIFS arising from the impact of changes in the market rates and relevant benchmark rates on the return on assets and on the returns payable on funding.

Rate of return risk differs from interest rate risk in that IIFS are concerned with the returns on their investment activities at the end of the investment holding period and with the impact on net income after the sharing of returns with IAH.

Rate of return risk lead to Displaced Commercial Risk refers to the magnitude of risks that are transferred to shareholders in order to cushion the IAH from bearing some or all of the risks to which they are contractually exposed in Muḍarabah funding contracts

Rate of Return Risk

Appropriate systems for identifying and measuring the factors which give rise to rate of return risk (RRR)

Employ gapping method while calculating rate of return The measurement of RRR highlights the importance of cash flow

forecasting Take into account non-contractual behavioral maturity of the

transactions• Early settlement and rebates

Balance sheet techniques to minimize exposures• Varying future profit ratios• Developing new Shariah compliant instrument• Issuing securitization tranches of Shariah permissible assets

Principles 6.1: Rate of Return Risk Management Process

Rate of Return Risk (cont’d)

Pressure of payment of competitive rates to IAH when return on underlying assets is underperforming e.g. financing provided on Murabaha basis for long term (on fixed rate) but market profit rates go up forcing IIFS to give better return to its IAH.

• linking to Benchmark

Displaced commercial risk is the consequence of the rate of return risk• To cover under-performing return on assets financed by IAH compared

with competitors’ rates: o Forfeiting bank’s Mudarib fee

Pressure on IIFS to attract and retain investors (IIFS may waive their rights to part or entire Mudarib share of profits)

o Profit equalization reserves (PER)

• To cover future investment losses of manageable magnitude: o Investment risk reserves (IRR)

• To absorb unexpected losses with a higher net impact: o Third Party Funds- Other than Shareholders funds

Principles 6.2: Displaced Commercial Risk Management


Reducing Mudarib fees to protect returns to IAH To cover under-performing return on assets financed by

IAH compared with competitors’ rates Remains a management decision IIFS is eligible, under the Mudarabah contract, for a

Mudarib (management) fee, which typically constitutes 20-40% of asset yields net of PERs.

In case asset yields deteriorate, the IIFS could reduce management fees ex post

although unilateral increases of Mudarib fees are strictly forbidden

This is viewed as a gift of the bank to IAH to earn their loyalty across the relationship


Forfeiting the Mudarib Fee


Profit Equalization Reserve (PER) Amount appropriated out of the gross income, before allocating

the Mudarib share to maintain a certain level of Return on Investment for IAH and increase owners’ equity.• Simply, refers to reserves set aside from Muḍarabah profits

before applying the profit-sharing distribution; hence, part of the PER is a component of shareholders’ equity and the remainder is a component of the equity of IAH

Their purpose is to provide an excess return to IAH in periods where assets have performed worse than expected, and therefore when yields on IAH might be lower for a given IIFS than for its Islamic and conventional peers.

Basis for computing the amounts so appropriated should be pre-defined and agreed with IAH (for disclosures relating to PER and IRR see IFSB-4).


Investment Risk Reserve (IRR)Is the amount appropriated by IIFS out of income of unrestricted

IAH, after allocating the Mudarib share, in order to cushion the effects of the risk of future investment losses on IAH.

Terms and conditions whereby IRR can be set aside and utilised should be determined and approved by the BOD.

Third Party Funds- Other than Shareholders’ FundsConstitute the ultimate line of defense against DCR Should Mudarib fee cuts, IRR and PER are insufficient to protect

IAH from excessive volatility regarding returns, third parties like govt. can use their funds to compensate for possible losses of IAH

Most of the Shariah scholars do not allow shareholders bailing out IAHs, because one party in the Mudarabah contract can not guarantee funds of other party



Profit from Investments

Profit BeforeDistributions

Shareholders IAH

PER

IRR

Distribution of profit

Distribution of reserves

Transfer fromShareholders’

profits

ForgoingMudarib’s

Share

Profit Equalisation

Reserves (PER)

Investment Risk Reserves

(IRR)

The % taken from Mudarib share is varying

Based on management decisions in line with the approval from BOD

Based on Hibah The shareholders accept the risks

attached to the UIAH funds

Appropriation before distribution of profit to shareholders and IAH

Setting aside from profitattributable to IAH afterdeducting Mudarib’s share

Share-holders’ Funds

IAH’sFunds

Techniques of Smoothing Payout to Investment Account Holders (IAH)

Issues in Smoothing Practices IAHs have no control over usage of these reserves and even in

some cases they are not informed of their IIFS maintaining any such reserves.

An IAH with a long-term investment perspective may find it useful to delegate the inter-temporal allocation of his income to IIFS. However, an IAH with a short-term investment perspective may be negatively affected by the building of reserves which most likely will be used for benefit of someone else.

The IRR may give rise to moral hazard problems similar to those arising from deposit insurance schemes, since the existence of IRR in IIFS is likely to encourage management to engage in excessive risk taking.

Harmonization/ Standardization issues• What type of reserves• Minimum or Maximum deduction/ Maximum sixe of reserves• Whether to transfer all the profit to shareholders after reaching the

max.


Thank you for your [email protected]

Reference:a) IFSB FIS workshops and standardsc) Naimi Shuib, FSI-AMF Liquidity Risk presentations 2014

mailto:[email protected]

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