risk mgmt in ib-bank islam

8/3/2019 Risk Mgmt in IB-Bank Islam

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IN ISLAMIC BANKIN ISLAMIC BANK

MD AROP OTHMANMD AROP OTHMANRISK MANAGEMENT DIVISIONRISK MANAGEMENT DIVISION

BANK ISLAM MALAYSIA BERHADBANK ISLAM MALAYSIA BERHAD

15 NOVEMBER 200715 NOVEMBER 2007

Bank Islam reserves all propriety rights to the contents of this Presentation. No part of this Presentation may be used or reBank Islam reserves all propriety rights to the contents of this Presentation. No part of this Presentation may be used or reproproduced in any formduced in any form

w ou an s am s pr or wr en perm ss on.w ou an s am s pr or wr en perm ss on.

This Presentation is provided for information purposes only. Neither Bank Islam nor the Presenter makes any warranty, expresThis Presentation is provided for information purposes only. Neither Bank Islam nor the Presenter makes any warranty, expressedsed or implied, noror implied, nor

assumes any legal liability or responsibility for the accuracy, completeness or currency of the contents of this Presentationassumes any legal liability or responsibility for the accuracy, completeness or currency of the contents of this Presentation..

STRICTLY PRIVATE & CONFIDENTIAL


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ContentContent

Introduction to Risk Management

Risk Management for Islamic Banks

Principles of Risk Management

Risk Mana ement in Bank Islam

INCEIF-LOFSA WORKSHOP, LABUANPage 2


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Concept of r isk management

Definition of risk

Risk management process

Im act of oor risk mana ement



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Concept of risk management in IslamConcept of risk management in Islam

Text in Al-Quran

O my children, do not enter the capital of Egypt by one gate but go into it by

different gates. However, know it well that I cannot ward off you Allahs will for

none other than He has nay authority whatsoever. In Him I have put my trust.

(Surah Yusuf: Verse 67)

a rom rop e u amma s.a.wProphet (peace be upon him) once asked a Bedouin who had left his camel

untied, Why do you not tie your camel? The Bedouin answered, I put my trust


. ,

trust in God.


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What is r isk?What is r isk?

Risks are uncer t ain f ut ure event swhich could influence the

achievement of the Banks objectives, including strategic,

operat ona , nanc a an comp ance o ect ves.

Uncer t ain f ut ure event scould be:

Failure of a borrower to repay a financing

Fluctuation of foreign exchange rates

Fraud, incomplete security documentations, etc

Non-compliance with shariah law and principles

Other events that may result in a loss to the Bank



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What is r isk management?What is r isk management?

Risk management is the processby which various risk

exposures are

(1) identified,

(2) measured/assessed,

,

(4) reported and monitored.



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Lesson learnt from poor r isk managementLesson learnt from poor r isk management

1. Barings Bank

- Nick Leeson singled handedly destroyed a bank

. um tomo

- The trader hid the losses while trading in the copper futures

- The company loss USD2.6 b

3. Daiwa Bank

- The trader hid the losses while trading in bond market- .

4. Orange County

- There was lack of management control over the trader

- The company lost USD1.69 b in the derivatives market



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Islamic banking business activities

Risks inherent in Islamic banking business

Uniqueness of Islamic banking

Risk issues for Islamic banks

Shariah non-compliance risk

Rate of return risk/Displaced Commercial risk

Inventor risk

Completion risk

Risk transformation at different stages of contract



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Islamic banking business act ivit iesIslamic banking business act ivit ies



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Balance sheet of Islamic bankBalance sheet of Islamic bank

Prof it & Loss

Islamic bankCustomer Depositors

Revenue Dividen/Hibah

Financing Deposit

Balance SheetAssets Liabilit ies

-

Murabahah/Ijarah/Istisna/Salam

Prof it sharing t ransact ions Investment accountsMudharabah/Musharakah Mudharabah

Fee based services Special investment accounts

Mudharabah/Musharakah

Equity

Off Balance Sheet


Rest ricted investments Direct investors


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Risk profi le of Islamic bankRisk profi le of Islamic bank

DisplacedCommercial

risk

Shariahnon-compliance

riskue

Rate of ret urn r isk EquityInvestmentrisk

U

ni

Islamic bank

Operationalrisk

CreditRisk

ric

Liquidity riskMarket

risk

Gen

St rategic Legal Fiduciary Reputat ion Transparency Regulatory compliance



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Generic risks for banksGeneric risks for banks

Types of r isks Def init ion

Credit r isk The potential that a counterparty fails to meet its

of credit-related contract

Market r isk The potential impact of adverse price movements such as, ,

the economic value of an asset

Liquidi ty risk The potential loss arising from the Banks inability either tomeet ts o gat ons or to un ncreases n assets as t ey

fall due without incurring unacceptable costs or losses

Operational r isk The potential loss resulting from inadequate or failed

internal processes, people and system or external events



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Risks transformation for financing of assetsRisks transformation for financing of assets

Even generic risks are not st raight forward in Islamic banking

For financing that involves financing assets eg Murabahah, Salam,Ist isna and I arah the risks of f inancin ma t ransform from credit to

market and vice versa at dif ferent stages of cont ract Hence capit al requirement needs to take into account both t he credit



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Risk t ransformat ion under Murabahah & MPORisk t ransformat ion under Murabahah & MPO

ura a a an se s asse s a rea y owne o cus omer a cos +

Murabahah Purchase Orderer (MPO) Bank sells assets it acquires to customer at

cost + based on promise to purchase (PP) by customer

Type of cont ract Stage of cont ract Credit r isk Market r iskMurabahah and

-Asset available for sale (asset on - X

Murabahahpurchase order

Asset is sold to and payment is due

from customer

X -

settlement

- -

Binding Murabahah

Purchase Order

Asset available for sale (asset on

balance sheet

X -

Asset is sold to and payment is due

from customer

X -

- -


settlement


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Risk t ransformat ion under Ij arah & IMBRisk t ransformat ion under Ij arah & IMBIjarah Bank owns the assets whilst transferring the right to use the asset to lessee. Liabilities & risks pertaining to

Type of cont ract Stage of cont ract Credit r isk Market r isk

e asse s orn y an

IMB Bank promise to transfer the asset by sale or hibah & MUST be separately expressed and independent of

underlying Ijarah

Operat ing Ij arah Asset available for lease (prior tosigning of a lease contract)

- X

Upon signing a leasing contract and X Xthe asset is available for lease

Maturity of contract term and the

leased asset is returned to the bank

- X

Ijarah MuntahiaBittamleek

Asset available for lease (prior to

signing of a lease contract)

- X

Upon signing a leasing contract and X -

the asset is available for leaseMaturity of contract term and the

leased asset is sold and the - -


owners p o asse s rans erre o

the customer


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Unique r isks for Islamic banksUnique r isks for Islamic banks

Types of r isks Definit ion

Shariah non-compliance r isk

Risk arises from the failure to comply with the Shariah rules

and principles

Rate of return r isk The potential impact on the returns caused by unexpectedchange in the rate of returns

Displaced Commercialrisk

The risk that the bank may confront commercial pressure to

pay returns that exceed the rate that has been earned on its

assets financed by investment account holders. The bank

its fund providers and dissuade them from withdrawing their

funds.

E uit Investment r isk The risk arisin from enterin into a artnershi for the

purpose of undertaking or participating in a particularfinancing or general business activity as described in the

contract, and in which the provider of finance shares in the


us ness r s . s r s s re evan un er u ara a an

Musharakah contracts.


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Salient features of Islamic bankingSalient features of Islamic banking

- .

FEATURE WHY?

-

It cannot earn more money by itself withoutputting it into real productive actions.

knowledge (gharar)-free

caused by the lack of knowledge.

3. Gambling (maysir)-free Zero-sum game wherein it just transfers thewealth, not creating new wealth.

4. Not involved in selling or

leasing or partnership in

something is impure or not halal

Religious and ethical value consideration or

public policy.

5. Not in direct conflict withestablished Shariah principles

in muamalah.

To ensure every contract behaves in its propercontext.

This does not negate freedom of contract


urr ya a - a aqu


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Examples of Shariah issuesExamples of Shariah issues

Completeness of aqad (contract) risk

Murabahah Contract

.

2. Buyer3. Asset to be t ransacted

.

Additional

requirements

1. The original pr ice of the asset is known t o the buyer

2. Transparent in t erms of profi t to be taken by the seller

3. Payment must be made wi th something of legal tender value

4. Not ribawi commodities



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.

Disclosure of the hibahon the rate board, website etc.

Gift to depositors

Shariah non-compliance fund

.

Guarantee on the capital and return

Maintenance cost on the Mudharabah deposit account


.




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4. Sale (Bai Inah & BBA)

MPO Ownership of the asset prior to sale aqad

-

The word agree in the aqad

Financing of non-Shariah compliant asset

Financing of asset intended for non-Shariah compliant activities

5. AITAB

Appointment of customer as the Banks purchasing agent prior to Ijarahcontract



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6. Trade Financing

Commitment fee on the unutilized line

, .

7. Refinancing

Refinancing of encumbered property

8. Recovery

Repossession - BBA



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Implicat ions of Shariah nonImplicat ions of Shariah non--compliancescompliances

Non Financial Impact s Financial Impact s

Against the commands of Allah.

Impediment from Allahs blessing or

Invalidation of contract (aqad)

Non-halal income

ara a

Contravention of the provision of

Islamic Banking Act 1983 (Section

Capital adequacy ratio (CAR) Impact

a ec on

Jeopardize the Banks reputation as

an Islamic bank



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Rate of Return RiskRate of Return Risk

Associated with the management of assets and liabilities

Fixed rate long term assets funded by variable rate short-term liabilities

ovement n enc mar rates may resu t n un prov ers av ng

expectations of a higher rate of return

Subsequently, it may result in displaced commercial risk where due to

market pressure, Islamic bank needs to pay a return that exceeds the rate

that has been earned on its assets.

,

providers which could consequently lead to liquidity risk



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Profit distributionProfit distribution

Income frominvestment

Income fromfinancing

Income fromIMM investing

Less:Net trading income and other income

Financing and investment loss provision

Profit equalisation reserve

Net Distr ibut able Income

Direct expenses

Profit Sharing Ratio

Investment Risk Reserve


Depositor Islamic bank


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BASEL Commit tee on Banking Supervision

Islamic Financial Services Board (IFSB)

Bank Negara Malaysia



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BASELBASEL

1988 Capital Accord (Basel I) Regulatory based

Set out requirements to calculate capital charge ie the amount of capital to be

One size fits all

Market Risk was incorporated into Basel I

2004 Internat ional Conver ence of Ca it al Measurement and Ca it alStandards (Basel II)

Aims to make capital requirements more risk sensitive

Includes Operational Risk

Bank shall be subject to 3 mutually reinforcing pillar Pillar 1: Minimum Capital requirements

Pillar 2: Supervisory Review Process



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IFSBIFSB

2005 Guiding Principles of Risk Management

2005 Capital Adequacy Standard

orporate overnance

2007 Supervisory Review Process



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IFSB Guiding Principles of Risk ManagementIFSB Guiding Principles of Risk Management

15 guiding principles which cover

General re uirement for an effect ive r isk mana ement rocess 1

Credit r isk (4)

Equity Investment Risk (3)

Liquidity Risk (2)

Rate of Return Risk (2) Operational risk (2)



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General requirement

Princi le 1.0 IIFS shall have in lace a com rehensive risk mana ementand reporting process, including:

A ro riate Board and Senior Mana ement oversi ht

Identify, measure, monitor, report and control relevant categories of risks

Held adequate capital against risk

Adequate risk reporting to the supervisory authority



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Shariah non-compliance

Princi le 7.1 IIFS shall have in lace ade uate s stems and controls,including Shariah Board/Advisor, to ensure compliance with Shariah rules

and principles

Requirements:

IIFS shall ensure that they comply at all times with the Shariah rules and

rinci les

IIFS shall ensure that their contract documentation complies with Shariah rules

and principles

IIFS shall undertake a Shariah compliance review at least annually

IIFS shall keep track of income not recognised arising out of Shariah non-compliance and assess the probability of similar cases arising in the future



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Rate of return r isk

Princi le 6.1 IIFS shall establish a com rehensive risk mana ementframework and reporting process to assess the potential impacts of market

factors affecting rates of return on assets in comparison with the expectedrates of return for investment account holders

Principle 6.2 IIFS shall have in place an appropriate framework for

mana in dis laced commercial risk, where a licable



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IFSB Capital Adequacy StandardIFSB Capital Adequacy Standard

e nee or ramewor

To ensure that Islamic banks can absorb a reasonable level of losses before

becoming insolvent.

To provide protection to depositors and/ or PSIA the higher the CAR, thehigher the level of protection.

To promote stability and efficiency of the financial system by reducing the

likelihood of Islamic banks becoming insolvent.

To ensure that the Islamic banks capital position commensurate with itsoverall risk profile and strategy.



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IFSB RWCR - St andard Formula

Eligible Capital

Total RWA (Credit + Market Risks) + Operational Risk PSIA isis

> 8.00%

LessLess

RWA funded by PSIA (Credit + Market Risks)

SharingSharing

InvestmentInvestmentAccountAccount



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IFSB RWCR -Supervisory Discret ion Formula

Eligible Capital

Total RWA (Credit + Market Risks) + Operational Risk

LessLess

RWA funded by Restricted PSIA (Credit + Market Risks)

LessLess

LessLess

[RWA funded by Profit Equalisation Reserve (PER) and Investment Risk Reverse (IRR)

of Unrestricted PSIA (Credit + Market Risks)]



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Risk Management Framework

Organisat ional St ructure

Policy and Guidelines

Enablers



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Risk Management Framework (RMF)Risk Management Framework (RMF)

Providing an architecture that governs the overall risk management

philosophy and strategy

c ng as a oun a on o a ow managemen o r s s o e con uc e mos

effectively in line with the industrys best practices

risk


C M h d lC M h d l


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Concept & MethodologyConcept & Methodology

SOLAH THE PILLAR OFISLAM

PHILOSOPHY OFSOLAH IN LIFE

BANK ISLAMS RMF

NIYYAH

Pronouncement/ Statement of Solah

MISSION STATEMENT MISSION & OBJECTIVES

Implementation Structure of Solah

RULE OF LAW

STRUCTURE

POLICIES & GUIDELINES

FUNCTIONAL STRUCTURE

Necessary Elements of Solah

RUKUN

RULE OF LAW

PROCEDURE

POLICIES & GUIDELINES

PROCESSESEssential Activities of Solah

QAEDAH

Facilities Required for Solah TOOLS

PROCESSES

ENABLERS


Facilities Required for Solah

F i l SF i l S


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Funct ional St ructureFunct ional St ructure

BOARD OFDIRECTORS

Other Board

Committees

Board RiskCommittee (BRC)

Constitution

As per BNM guidelinesFunction

Risk Mgmt Oversight and Over-riding

authority for Risk Mgmt

Shariah SupervisoryCouncil (SSC) Board FinancingReview Committee

Managing Director

pprova o u m ss ons

Functional

SHAREHOLDER

MANAGEMENT

Internal AuditDepartment

(BFRC)

FinancingCommittees(FCA, FCB, RFC)

Management RiskControl Committee(MRCC)

Administrative

Other Management

Committees

Business Units

( C , C , C) ( CC)Risk Management Division(RMD)Business Support Units

Market RiskCredit RiskOther Corporate

Support Units

Asset LiabilityCommittee (ALCO)

Credit AnalysisCredit Administration

Business Risk ControlShariah Compliance

Risk


omp ance

Operational Risk

P li i & G id liP li i & G id li


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Policies & GuidelinesPolicies & Guidelines

Policies for principle risk areas are in place covering areas of credit,market, operational and Shariah compliance

Policies are su orted b Guidelines and further su orted b o erat ionalmanuals to ensure policies are implemented properly

Approving authority

RMF Board

Policy Board

Manual - Stakeholders

All policies, guidelines and manuals are reviewed annually to ensure

consistency and in line with business reality


C dit i kC dit i k


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Credit r iskCredit r isk

Policy Guidelines

Credit Risk Policy - The policy addressesthe broad credit management framework

1. Pricing Matrix Guidelines

2. Acceptance Let ter Offer Guideline

that covers the objective, strategy,

structure and credit processes in order toestablish the best practices in the

3. Negat ive List Guideline

4. Collaterals Guideline5. Valuat ion Guideline

with the regulatory requirements.

.

7. Sovereign Risk Guideline

8. Consumer Grading Guideline

9. Sectoral Guideline

10. Business Relationship EtiquetteGuideline

11. Watchlist Guideline

. nanc ng rocess u e ne

13. Credit Recovery Guideline

14. Guidelines on Risk Adj usted Pricing forCor orate & Commercial


Market r iskMarket r isk


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Market r iskMarket r isk

Policy Guidelines

ar e s o cy escr es e s o cyand Analytics, Asset and Liability Management

(ALM) and Middle Office functions of the

Market Risk Department

.

2. Hedging Guideline

3. Mark-to-Market Guideline

4. Rate Reasonabil ity Check Guideline

Trading Book Policy - Addresses market riskfactors which include but not limited to profit

rate or rate of return forei n exchan e

5. Value-at -Risk (VaR) Guidel ine

6. Asset and Liabil ity ManagementGuideline

equity and commodity risks inherent in the

Banks trading and banking books

. ar e s anua roce ures


Operat ional r iskOperat ional r isk


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Operat ional r iskOperat ional r isk

Policy Guidelines

pera ona s o cy e po cy prov esthe effective and efficient operational risk

management through out the Bank through its

strategies in terms of organization structure,

.

2. Management Awareness and Self-

3. Assessment (MASA) Reporting Guideline

4. Fraud Handlin and Re ort in Guidelineprocess, r s o erance, r s measuremen an

analytic model management information

system

5. Takaful/Insurance Guideline

6. Key Risk Indicators (KRIs) Guideline

7. Outsourcing Guideline8. Operational Risk Management Process for

Information Security Management System

9. Customer Complaint Guideline

.


Sh i h li i kSh i h li i k


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Shariah compliance riskShariah compliance risk

Policy Guidelines

Shariah Compliance Risk Management 1. Wadiah Contract Guideline.Policy The policy provides the Shariah

requirements applicable throughout theBank in its activities, products and

services in compliance with the Shariah

2. Ij arah and Ij arah Muntahiah Bit Tamlik

Guideline3. Murabahah and MPO Cont ract Guideline

principles, provisions of the Islamic

Banking Act 1983 and Bank Negara

Malaysias rules and regulations.

. u ara a nanc ng ont ract u e ne

5. Musharakah (financing) Contract Guideline

6. Handling and Report ing of Shariah Non

Com liances Guideline

7. Mudharabah (Deposit) Contract Guideline

8. Musharakah Mutanaqisah Contract Guideline

9. Dhamanah/ Kafalah Contract Guideline

10. Wakalah Contract Guideline

11. Tawarruq Contract Guideline


Process of risk managementProcess of risk management


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Process of risk managementProcess of risk management

Awareness & Identification

Knowing what the risks/risk areas are

Assessment & Measurement Analytical ability to assess & measure risks

Mitigation & Control

Identif in & a l in a ro riate miti ations & controls of identifiedrisks/risk areas

Monitoring & Reporting

Continuous monitoring & appropriately reporting identified risks/risk areas


EnablersEnablers


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EnablersEnablers

Tools to assess and monitor risk issues include: Key Risk Indicator (KRI)

Management Awareness and Self Assessment (MASA)

Risk Profiling

Portfolio / Exposure tracking Customer Ratings

Value at Risk (VaR)

Systems to manage risk issues Core Banking and Middle-wares

Financing Origination & Collection Systems

Treasur Middle Office s stems - QRisk, Quantum

Operational Risk Management System Administrative systems


Managing Shariah nonManaging Shariah non--compliance riskcompliance risk


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Managing Shariah nonManaging Shariah non compliance riskcompliance r isk

Shariah Supervisory

Council

unc ona s ruc ure

Audit

CBNM

Sharia

Shariah Department

Examina

tio

mmittee

er

nalAudit

Audit

AuditU

nit

IAD

n

Ex

Shariah Complianc eRisk Mgmt

of

Shariah Com plianc e

Board RiskCommittee

Risk Working Group




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Managing Shariah nonManaging Shariah non compliance riskcompliance r iskFunctional structure

Funct ion Key Roles and Responsibilit ies/ Remarks

ShariahSupervisory

Structurally reports to Board, but functionally is independent of the Board and

management of the Bank.

ounc Governed by BNM GPS1

ShariahDepartment

Suppor t the SSCs funct ion on day-to-day basis Providing Shariahadvice based on the decisions ofShariahcouncils

on uc ng ra n ng on ar a re a e ma ers.

SCRMDepartment

Third layer of cont rol mechanism after SSC and SD.

Facilitating the process of managing SCR in the Bank.

Performing independent evaluation on products, manual & guidelines

Monitoring SNC and keeping track of income arising from SNC

Identifying internal control weakness and recommending mechanism to address

the SNC.

ShariahCompliance

Sub-committee of Management Risk Control Committee established to beresponsible for developing the SCRM capability of the Bank.


Group

a rman: , epu y a rman: , ecre ary: ea o an

members: Senior officers from Business and Support Units.



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Managing Shariah nonManaging Shariah non compliance riskcompliance r isk

wareness en ca on Conduct Shariah awareness program to all staff

Incorporate Shariah requirement in operational manuals

Newsletter on quarterly basis

Risk portal

Assessment & Measurement Develop Shariah compliance risk scorecard

Shariah assessment on new products, initiatives, manuals

Mitigation & Control

Issue policy and guidelines Establish Shariah Compliance Risk Working Group

Shariah representative in all committees

Require sign off

Monitoring & Reporting Shariah non-compliances tracking report Key Risk Indicators

Monthl re ortin to MRCC and BRC


Key Risk Indicators ReportKey Risk Indicators Report


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Key Risk Indicators ReportKey Risk Indicators Report

. Objectives of the parameter:

To promote better understanding of Shariah compliance.

Shariah non-compliance is ZERO TOLERANCE

To provide a benchmark in determining the level of SNC.

RATING DEFINITION DESCRIPTION

1 Very Satisfactory No potential SNC case being reported to.

2 Satisfactory Detection of 5 cases of PSNC.

3 Fair Detection of 6 - 10 cases of PSNC.

4 Unsatisfactory Detection of > 10 cases of PSNC.

5 Very Confirmation of at least 1 SNC by SSC.


Unsatisfactory

Shariah compliant is crucialShariah compliant is crucial


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Shariah compliant is crucialShariah compliant is crucial

Original basis for having a banking system that meets the religiousrequirements of Muslim in line with their Aqidah.

actor t at st ngu s es s am c an ng rom convent ona an ng.

Ensures acceptance, validity and enforceability of contracts from Shariah

.

Fulfills the objectives of Islamic finance i.e. to achieve justice ( adalah)

.



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Thank You

Wassalam


risk mgmt in ib-bank islam

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