Risk Management Framework for Shari’ah Compliant Banking

Banks must have in place sound processes for managing credit risk in Shari'ah compliant financing contracts, including processes for: 7.3.1 continued monitoring of counterparty's ability and willingness to repay under the terms of the financing, performance of the underlying assets; processes for classification of the performance of the credit exposures; 7.3.2 tracking, triggering and reporting credit exposures that require prompt action; 7.3.3 monitoring completeness of documentation, counterparty's compliance with terms and conditions and other contractual requirements of the Shari'ah compliant contract, collateral and other forms of credit risk mitigation; 7.3.4 identifying different types of risks involved in a Shari'ah financing transaction, and measuring credit risk and other risks (where applicable) for each different type of Shari'ah financing contract (e.g. financing contract based on PSIAs) and at different stages of the underlying contracts (e.g. contracts which involve purchase and sale of commodities); 7.3.5 assessing and ensuring credit risk mitigating techniques used in each Shari'ah compliant financing are legally enforceable and compliant with Shari'ah rules and principles; 7.3.6 identifying problem credits on a timely basis and implementation of workout, restructuring, rescheduling, recovery, or other appropriate measures, and ensuring compliance with Shari'ah rules and principles. 8. Market Risk 8.1 Principle 3.0 : Banks must 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 liquid market and/or are exposed to high price volatility. 8.2 Banks must develop a market risk management strategy including the level of acceptable market risk taking into account contractual agreements with fund providers, types of risk-taking activities and target markets to ensure that exposures remain at or below the pre-determined levels and within the limit of the bank's risk bearing capacity. Banks should review the strategy periodically, communicate to relevant staff and disclose to fund providers. 8.3 Banks must establish a sound and comprehensive market risk management system and processes which shall include: 8.3.1 processes for identifying underlying market risk exposures arising from Shari'ah compliant contract; 8.3.2 setting a middle office or an independent market risk management function to monitor, measure and analyze risks inherent in the treasury operations of a Shari'ah compliant banking activities and periodically report to senior management market risk exposures and risk mitigation and control measures; 8.3.3 policies, procedures and systems for pricing, valuation and income recognition; and 8.3.4 effective management information system for monitoring and measuring asset risk exposure and performance, and reporting to senior management and board. 8.4 Banks must, at all time, be able to quantify market risk exposures, analyze and report to senior management and board their exposure to potential losses in their net open asset positions both under normal and stressed market conditions. 8.5 Banks must assess the market structure including consideration on the level of liquidity giving rise to heightened market risk, and availability of market prices in assets where the bank is exposed to. For example, assets traded in illiquid markets may not be realizable at prices quoted in other more active markets. In the valuation of assets where no direct market prices are available, banks should have in place valuation framework and methodologies for their market risk positions, which may include appropriate forecasting or valuation models to estimate the value of assets.