FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Workshops on
Facilitating the Implementation of IFSB Standards
CAPITAL ADEQUACY STANDARD
FOR Institutions ( Other than Insurance Institutions)
Offering only Islamic Financial Services
Cairo, Egypt
27 – 28 August 2008
All rights reserved. No part of this publication may be reproduced, translated, stored in or introduced into a retrieval
system or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise),
without the prior written permission of the Islamic Financial Services Board.
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Case Study
Measurement of Capital
Adequacy Ratios of an IIFS
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Learning Objectives
Participants will be able to:

Understand the background for and context of the IFSB-CAS

Identify and classify the risks associated with Shari’ah compliant
instruments


Define data requirements for:
o
the key calculations for the relevant approaches and;
o
the main exposure types
Execute the basic calculations for the capital adequacy formulas
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Methodology
Capital adequacy ratios using IFSB and Basel II are calculated
based on:
Type of Risk
Basel approach
Credit Risk
Standardised Approach
Market Risk
1996 Market Risk Amendments
(Standardised Measurement Method)
Operational Risk
Basic Indicator Approach
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Assumptions
Credit Risk
1. All International Murabahah and Wakalah attract a RW of 50%,
as they represent transactions with high credit quality rated
international banks with residual maturity up to 3 months
2. Murabahah and Ijarah
preferential risk weights
(in local currency) treated under
 50% of Murabahah & Ijarah are for retail business; and
 50% of Murabahah & Ijarah are over collectivized by RRE
3. Investment in Government Musharakah Sukuk are treated as
Sukuk held in the banking book
4. No past due receivable
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Assumptions
cont’d
Market Risk
5. For inventories, book values = market values of the commodities at spot
market prices
6. Residual value of assets leased = amount receivable from operating Ijarah
less 10% depreciation
Sources of Funds
7. Percentage of assets funded by unrestricted PSIA is 27%
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Balance Sheet
• To Identify risks associated
with Shari’ah compliant
products
• To classify risks
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Liabilities
Assets
Cash & cash equivalent (local)
7,640,300,010.54
Current Accounts (local)
33,095,265,730.85
Cash & cash equivalents (foreign)
3,666,429,588.06
Current Accounts (Foreign)
51,134,349,148.22
Correspondents A/Cs
5,319,257,257.77
Account Receivables
Other A/Cs (foreign)
International Murabahah (foreign)
47,395,740,416.74
Wakalah (foreign)
13,232,002,133.74
Murabahah (local)
21,198,540,883.65
Istisnaa
7,190,999.45
Ijarah
2,589,290,037.89
Qard
839,980,349.77
Diminishing Musharakah
other A/Cs (local)
492,485,700.62
33,492,930.20
Sub-total
84,755,593,509.89
Unrestricted investment accounts (local)
26,040,775,217.25
Unrestricted investment accounts (foreign)
Sub-total
9,374,904,225.32
35,415,679,442.57
2,297,075,300.36
Mudarabah
147,785,420.15
Properties held for sale
179,733,023.67
Other liabilities
4,462,923,826.89
Owner equities
7,843,632,007.01
Investments
Investment in Govt. Musharakah Sukuk
18,257,778,137.78
Investment in equities (subsidiaries)
1,804,968,610.01
Other assets
2,956,549,000.00
Fixed Assets
4,742,207,616.78
Total On-balance sheet items
Off/balance sheet items
Total assets
132,477,828,786.36
30,573,255,130.56
163,051,083,916.92
Total on-balance sheet items
132,477,828,786.36
Contingent liabilities
Acceptance Commitments
7,435,832,969.93
L/Gs commitments
1,645,478,824.17
L/Cs Commitments
10,891,835,984.49
Other commitments
10,600,107,351.97
Total Liabilities
163051083916.927
© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Basel I
Calculation of capital adequacy ratio:
 A brief reminder
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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IFSB-CAS
Calculation of Capital Requirements
for Credit Risk
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Calculation of Capital Requirements for Credit Risk
FORM C1: Summary Table for Credit Risk Capital Requirements
Ref
Category
Form C2
RWA for individual claims based on ECA
Form C 3
Exposure
RWA
CAR
Capital Requirements for
Credit Risk
0
0.00
8%
0.00
RWA for short-term exposures & other assets
71,618,530.00
42,452,896.50
8%
3,396,231.72
Form C 4
RWA for exposures under profit sharing mode
18,257,778.00
0.00
8%
0.00
Form C 5
RWA for exposures with preferential risk weights
23,787,830.00
13,083,306.50
8%
1,046,664.52
Form C 6
RWA for past due receivables
0.00
0.00
8%
0.00
Form C 7
RWA for Off-balance sheet exposures
30,573,255.00
20,057,015.74
8%
1,604,561.25
144,237,393.00
75,593,218.74
Total
6,047,457.50
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Calculation of Capital Requirements for Credit Risk
FORM C3: RWA for Short-term Exposure and Other Assets
Credit Risk Mitigation Techniques
Exposure Type
Rating
RW
RWA
Original Exposure
Supervisory Haircut
1
Short-term Exposure
2
A-1/P-1
20%
A-2/P-2
50%
A-3/P-3
100%
Diminishing
Musharakah
others
Mudarabah
International
Murabahah &
Wakalah*
3
Simple Approach
Amount of
collateral
Haircut %
Adjusted
Collateral
Net
Exposure
RW of
counterparty
4
5
6
7
8
4(1-5)
(3-6)
9
(3 x 2) or (7 x 2) or
(3 x 8)
60,627,742.00
30,313,871.00
150%
2,297,075.00
3,445,312.50
Unrated
100%
147,785.00
147,785.00
Istisna
Unrated
100%
7,191.00
7,191.00
Qard
Unrated
100%
839,980.00
839,980.00
Other assets
100%
2,956,549.00
2,956,549.00
Fixed Assets
100%
4,742,208.00
4,742,208.00
71,618,530.00
42,452,896.50
Total Exposure
Refer to slide (5) - assumptions
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Calculation of Capital Requirements for Credit Risk
FORM C 4: RWA for Investments made under Profit sharing Mode
CRM
Exposure Type
Rating
RW
Original Exposure
Simple Approach
RW
RW of counterparty
4
1
2
5
3
(3x2) or (3x4)
Mudarabah
Simple Method
300%
Govt. Musharakah Sukuk
Joint Ownership of real estate and movable assets
400%
18,257,778.00
0%*
0
Slotting method
90%
100%
135%
270%
Total
* Assuming RW of Govt. is zero
18,257,778.00
0
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Calculation of Capital Requirements for Credit Risk
FORM C 5: RWA for Exposures with Preferential Risk Weights*
A
Exposure Type
1
Murabahah or Ijarah collateralized by
residential real estate
2
Murabahah or Ijarah collateralized by
Commercial real estate
3
Murabahah and/or Ijarah receivables from
individuals or small business (retail)
Total
RW
Amount of
Exposure
Value of
Collateral **
Haircut % ***
Value of eligible
collateral
Net
Exposure
RWA
1
2
3
4
5
6
7
3 ( 1 - 4)
(2 - 5)
(2 x 1 ) or (6 x 1)
35%
11,893,915.00
4,162,870.25
11,893,915.00
8,920,436,25
23,787,830.00
13,083,306.50
50%
100%
75%
* Preferential Risk Weights if the underlying assets are sold under Murabahah or leased under Ijarah
** collaterals other than real estate such as Hamish jiddiah or Urbon
*** Cash collateral in foreign currencies subject to a haircut of 8%
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Calculation of Capital Requirements for Credit Risk
FORM C 7: Off-balance Sheets Exposures
Exposure
CCF
Outstanding
Amount
Credit
Equivalent
Adjusted
collateral
Net Exposure
RW
RWA
1
2
3
( 1 x 2)
4
5
( 3 – 4)
6
7
(5 x 6)
L/Cs collateralized by underlying
shipments / goods
20%
10,891,836
2,178,367
450,677
1,727,690
100%
1,727,690
≤ 1 year commitments
20%
1,645,479
329,095
35,710
293,385
100%
293,385
≥ 1 year commitments
50%
others
100%
18,035,940
18,035,940
0
18,035,940
100%
18,035,940
30,573,255
20,543,402
486,387
20,057,015
Total
20,057,015
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
IFSB-CAS
Calculation of Capital Requirements
for Market Risk
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Calculation of Capital Requirements for Market Risk
FORM D 1: Summary of Market Risk Capital Requirements
Ref.
Capital
Requirements
Exposure
Form D2
Total Equity Risk Capital Charge
0
Form D3
Total Specific Risk Capital Charge for Sukuk positions
0
Form D4
Total General Risk Capital Charge for Sukuk and offbalance sheet financial instruments
Form D5
Total foreign exchange capital charge
Form D6
Total commodity risk capital charge
Form D7
Total inventory risk capital charge
CF*
0
12.5
RWA
0
12.5
12.5
**
2,776,214.00
Total
271,804.80
12.5
3,397,560.00
12.5
0
213,504.00
12.5
2,668,800.00
485,308.80
12.5
6,066,360.00
* reciprocal of minimum capital adequacy ratio
** This balance can be checked from the position in foreign currency
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Calculation of Capital Requirements for Market Risk
FORM D 5: Foreign Exchange Risk Capital Charges
Currency
US dollar (-)
Saudi Riyal (+)
Net Spot
1
Position
Net Forward
2
Position
3
Guarantees
Other Items
4
Net Long Position
27,891.74
Sterling P (+)
Euro (-)
Net Short Position
27,891.7
3,357,303.91
0.0
3,357,303.9
Jordanian Dinar
Qatar Riyal (-)
or
77.63
0.0
0.0
77.6
0.0
40,257.30
40,257.3
867,583.83
867,583.8
0.0
UAE Dirham (-)
372.16
372.2
0.0
Oman Riyal (-)
23.41
23.4
0.0
Bahrai Dinar (-)
22.41
22.4
0.0
895,971.2
3,397,561.2
Total Position
X
Y
Net Gold Position
Z
Capital charge calculation
Greater of Net Long Position (X)
or absolute value of Net Short
Position (Y)
3,397,561.2
Absolute value
Net Gold or Silver
Position (Z)
0.0
Capital Requirement
Total Capital Charge
8%
271,804.80
© ISLAMIC FINANCIAL SERVICES BOARD
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Calculation of Capital Requirements for Market Risk
FORM D 7: Inventory Risk Capital Charges
Market Value
Capital Charge
Capital requirement
Book Value
Properties held for sale
179,733.00
179,733.00
Salam (without parallel Salam)
15%
26,960.00
15%
Unbilled WIP inventory under Istisna without parallel Istisna
7,191.00
7,191.00
Residual value of assets leased*
2,589,290.00
2,330,361.00*
Total
2,776,214.00
2,517,285.00
1.6%
8%
115.10
186,428.90
213,504.00
*Assuming 10% depreciation , See slide (6) - Assumptions
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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IFSB-CAS
Calculation of Capital Requirements
for Operational Risk
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Calculation of Capital Requirements for Market Risk
FORM E: Operational Risk
2004
2005
2,006
Net income from financing activities
1,459,000
2,582,000.00
4,903,000.00
Net income from investment activities
22,000.00
68,000.00
76,000.00
578,000
1,413,000
2,547,000
2,059,000.00
4,063,000.00
7,526,000.0
13,648,000
340,000.00
715,000.00
1,632,000
2,687,000
Gross income
1,719,000.00
3,348,000.00
5,894,000
10,961,000
Average Gross Income
3,653,666.67
Fee income (e.g. commission and agency fee)
Less
Investment account holders' share of income
Assigned Capital Charge
Capital requirement for operational risk
Conversion factor
Operational Risk Weighted Assets
15%
548,050.00
12.5
6,850,625
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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IFSB-CAS
Calculation of Eligible Capital
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Calculation of Eligible Capital
FORM F: Eligible Capital
Tier 1 Capital
Amount
Issued and fully paid ordinary shares/common stock
7,000,000
Tier 2 Capital
Asset revaluation reserve
Perpetual non-cumulative preference shares
General provisions
Share premium
Hybrid capital instruments
Legal reserves
240,705
Amount
275,025
611,167
Subordinated debt of more than 5 years
Retained profit
Less:
Goodwill
TOTAL
7,240,705
275,025
Ratio of Tier 2 to Tier 1 = 3.8%
Tier 1 + Tier 2
= 7,515,730
Less : Investment in subsidiaries = 1,804,969
Total Eligible capital
=
5,710,762
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
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Calculation of CA ratios
Comparison:

IFSB formula

Basel II formula

Basel I formula
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Calculation of Capital Adequacy Ratios
IFSB Formula
a)
Total eligible regulatory capital which is used as the numerator for CAR
b)
Basel II formula
Basel I Formula
5,710,762.00
5,710,762.00
Total RWA for credit risk
75,593,218.74
75,593,218.74
c)
Total RWA for market risk
6,066,360.00
6,066,360.00
6,066,360.00
d)
Sub-total
81,659,578.74
38,580,152.00
e)
Total RWA for operational risk
f)
81,659,578.74
6,850,625.00
8,530,000.00
Total RWA
88,510,203.74
90,189,578.74
RWA (CR & MR) funded by profit sharing investment account holders
22,048,086.26
RWA (CR & MR) funded by restricted investment account holders
RWA (CR & MR) funded by unrestricted investment account holders
00
27%
5,710,762.00
32,513,792.00
38,580,152.00
00
22,048,086.26
RWA (CR & MR) funded by PER and IRR
g)
Minimum Capital Adequacy Requirements
h)
Total RWA - RWA funded by unrestricted PSIA( CR + MR) ( e – f)
o)
Standard Formula
p)
Supervisory Formula
66,462,117.48
8.6%
6.3%
14.8%
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© ISLAMIC FINANCIAL SERVICES BOARD
FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Group Exercise 4
Analyses:
The Impact of Balance Sheet Structure on
Capital Adequacy Ratio
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Balance sheet Structure of Hypothetical Banks
Bank A
10
40
25
Other
Mudarabah
Musharakah
CA + SA
Large PSIA portfolio
Significant Musharakah and
Mudarabah exposure
13
8
50
Istisna
10
Ijarah
5
Murabahah
Other
25
PSIA
Equity
15
1
Assets
1
Source: Modified from McKinsey
Liabilities
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FIS WORKSHOP SERIES
Balance sheet Structure of Hypothetical Banks
cont’d
Bank B
Limited PSIA within deposit base
10
Other
Limited Musharakah and Mudarabah
exposure
25
Other
Mudarabah
Musharakah
3
5
Istisna
8
60
CA + SA
25
Ijarah
PSIA
15
Mudarabah
35
Equity
15
1
Assets
1
Source: Modified from McKinsey
Liabilities
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Balance sheet Structure of Hypothetical Banks
cont’d
Bank C
10
Other
Other
25
Mudarabah
5
Musharakah
10
Significant Musharakah and
Mudarabah exposure
60
Istisna
10
Ijarah
15
Limited PSIA within deposit base
CA + SA
PSIA
Murabahah
15
35
Equity
15
Source: Modified from McKinsey
1
Assets
1
Liabilities
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FACILITATING THE IMPLEMENTATION OF IFSB STANDARDS
FIS WORKSHOP SERIES
Thank you …
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FIS WORKSHOP SERIES
Contact information
Mashair Mohammed Ibrahim
Assistant Project Manager
Islamic Financial Services Board
3rd Floor Block A, Bank Negara Malaysia Building
Jalan Dato’ Onn, 50480 Kuala Lumpur, Malaysia
P.O.Box 10591, 50714 Kuala Lumpur, Malaysia
Telephone: 603 – 26984248 ext. 135
Fax: 603-26984280
e-mail: mashair@ifsb.org
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FIS WORKSHOP SERIES
Summary of Capital Requirements for Shari’ah Compliant Contracts
Risk weights
Contract
Capital Charges*
Credit Risk**
Market Risk
CR + MR
Murabahah
 Inventory
 Asset delivered to a counterparty
N.A.
100%
187.5%
N.A.
187.5%
100%
15%
8%
Salam
 Salam without parallel Salam
 Salam with Parallel Salam
100%
100%
187.5%
287.5 % + 24%
287.5%
< 287.5%
23%
< 23%
Istisna
 Istisna without parallel Istisna
 Istisna with parallel Istisna
100%
100%
20%
N.A.
120%
100%
9.6%
8%
Ijarah
 Inventory
 Operating Ijarah
 IMB
N.A.
100%
100%
187.5%
100%
N.A.
187.5%
200%
100%
15%
16%
8%
300% - 400%
90% - 270%
Depends on the
underlying assets
≥ ( 300% - 400%)
≥ ( 90% - 207%)
≥ (24% - 36%)
≥ (7.2% - 21.6%)
Musharakah
300% - 400%
Depends on the
≥ ( 300% - 400%)
underlying assets
90% - 270%
≥ ( 90% - 207%)
* Capital charges do not include operational risk
** Provided the counterparty is unrated, otherwise the RW of the counterparty should be applicable
Mudarabah
© ISLAMIC FINANCIAL SERVICES BOARD
≥ (24% - 36%)
≥ (7.2% - 21.6%)
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