CBK-IIFM Seminar on Islamic Hedging, Liquidity Management and Sukūk

Transcription

1 CBK-IIFM Seminar on Islamic Hedging, Liquidity Management and Sukūk RISK MANAGEMENT IN ISLAMIC BANKS: THE CBK S REGULATORY APPROACH FOR ISLAMIC HEDGING, LIQUIDITY MANAGEMENT AND SUKŪK Session 1: Risk Management and Regulations in Islamic Banks JW Marriot, Kuwait City October 10, 2018 Dr. Jamshaid Anwar Chattha, CPIF Chief Banking Researcher and Islamic Finance Expert Central Bank of Kuwait

2 PRESENTATION SCOPE 2 Islamic Finance Relevance and Number Game and Kuwait Islamic Finance at Glance Risk Management at Islamic banks and their Prudential Regulation and Supervision The CBK s Approach for Liquidity, Sukuk, and Islamic Hedging

3 Islamic Finance: Growth and Number Game The global IFSI covering Islamic banking, Islamic capital markets and Takāful has surpassed the USD 2 trillion milestone in 2017 with an 8.3% growth in assets. 3 Global Islamic Banking Assets and Market Share Kuwait s financial system - bank centric - 84% of the domestic financial sector. We are here Total 11 Kuwaiti Banks (5-conventional; 5-Islamic; 1- Industrial Bank) + 12 Foreign Banks incl. one Islamic Islamic banks share represent one of the most significant presence of Islamic banks in any country across the globe with a dual banking system. Source: IFSB FSR 2018

4 Kuwait Islamic Finance At a Glance 4 Source: Central Bank of Kuwait (2018) - Islamic Finance in Kuwait: Broadening Horizons

5 Key Risks from an Islamic Bank s business Model and Risk Management Dimensions of Risk Management Islamic Bank level Profitability (Making Profits with risk) Supervisor Level Financial Stability Dual Banking Banking Book Trading Book IFSB/Basel II & III Various Risks: Credit, market, liquidity, Operational, equity invest., Rate of return risk Regulation + Supervision Capital adequacy Supervision Market Discipline Governance Risk Management Risk Management Tools: Stress Testing Value-at-risk Hedging Instruments BOD Collective oversight and risk governance ( Tone at the top ) Risk culture, risk appetite framework and RAS - CRO Three lines of defense Source: Chattha (2018)

6 The CBK s Approach - Regulation and Supervisory Review Process Supported by Legal, Accounting, and financial Infrastructure Central Bank Law No. 32 of the Year 1968 Articles (Islamic Banks) Regulation Governance Capital Adequacy - sound capital assessment Risk Management comprehensive assessment of risks Liquidity Management Macroprudential Policy Measures Board and senior management oversight Corporate Governance Shariah Governance Quality and capacity of Islamic banks capital to absorb losses Going concern (Tier 1) Gone concern (Tier 2) ICAAP and ERM Types of risks captured under Pillar 1 Types of risks not fully captured under Pillar 1 Five Pillars of Liquidity Management LCR + NSFR 20% Liquid Assets CCB LTV DSTI Supervision Supervisory approach - forwardlooking assessment of the risk profile of individual banks and banking groups Supervisory techniques and tools Mix of On-site and Off-site activities surveillance Intra-agency and inter-agency cooperation, coordination and information-sharing Consolidated supervision and Home-Host cooperation Source: Chattha (2017) CAMELS-BCOM Model, OSS, ICAAP, Stress Testing, Macroprudential toolkit Note: The above does not represent the exhausted list of CBK s regulations and supervision tools.

7 7 Risk Management and Stress Testing: Measuring the impact of ROR Risk. Need for Islamic Hedging Techniques Islamic Profit Rate Swaps Risk Management with Stress Testing and Supervision of Stress Testing.. How does it work? Supervisory Perspective Recession Stagnation Bank-run Market crash Natural disaster Contagion Guiding Principles? Templates? Fat-tails Top-Down vs. Bottom-Up Source: Chattha and Archer (2016); Chattha (June, 2016)

8 Measuring the impact of ROR Risk. Need for Islamic Hedging Techniques Islamic Profit Rate Swaps 8 Figure 1: ICBs and CCBs - EVE Risk as % of Capital 40% 20% 20% 10% 0% 0% -20% -10% -40% -20% -30% -60% -40% -80% -50% -100% -60% -120% % Base Line Scenario (100 bps) Moderate Scenario (200 bps) ICBs CCBs 21 4 Adverse Scenario (300 bps) Base Line Scenario (100 bps shock) Adverse Scenario (300 bps shock) Moderate Scenario (200 bps shock) Source: Chattha and Alhabshi (2018). Benchmark rate risk, duration gap and stress testing in dual banking systems. Pacific-Basin Finance Journal.

9 The CBK s Approach: Liquidity Risk and Shariah compliant lender-of-last resort (SLOLR) 9 First Line of Defense Five Pillars of Liquidity Banks Perspective Liquidity Coverage Ratio (LCR) Net Stable Funding Ratio (NSFR) 18% Liquid Assets Maximum Financing/Lending Limit Maturity Ladder Approach CBK s monetary operations - Liquidity absorption by CBK through intervention Robust Liquidity Infrastructure such as Inter-bank liquidity placements and RTGSS called as Kuwait s Automated Settlement System for Inter-participant Payments (KASSIP). High-quality liquid assets (HQLA) Outflows (30 days) - Inflows (30 days) Available Stable Funding (ASF) Required Stable Funding (RSF) Up to 90% of deposits Time Band 100% Max. limit of Cum. Gap 7 Days and under 10 % 1 month and under 20 % 3 months and under 30 % 6 months and under 40 % 100% Second Line of Defense Provision in Banking Law to provide liquidity on Shariah-compliant basis

10 The CBK s Regulatory Treatment of Sukῡk 11 Asset De-recognition Criteria - all credit risks (& price risk where applicable) have been transferred, no effective control over transferred assets, true sale & bankruptcy remoteness, and no claim against the originator. Sukūk rated by ECAIs are assigned risk-weights based on the assigned ratings according to the standardised approach; Unrated Sukūk - nature of the entity and nature of the contract upon which the Sukūk are based Trigger point and the conversion ratio, are to be clearly specified in the Sukūk contract so as to avoid gharar. Prior supervisory approval, If the instrument is callable. Profit Rate risk in trading positions in Sukūk: specific risk and general market risk; measurement through three methods: simplified (time-bands and weights), maturity (Zones, time-bands and weights), or duration (time-bands and assumed changes in yield).

11 The CBK s Regulatory Treatment for Shariah- Compliant Hedging Techniques 11 The CBK s Capital Adequacy Framework presents: Exposures to CCPs arising from OTC Sharī`ah-compliant hedging contracts. Islamic banks are not permitted to undertake derivative transactions for speculative purposes and should only use these to hedge their exposures. All positions by Islamic banks should also be compliant with Sharī`ah principles and approved by the respective SSB. The CBK have discretion to impose additional capital charges on such positions on a case-by-case basis. An example which illustrates the CCR treatment for Sharī`ah-compliant Hedging Contract and CVA Capital Charge, and replacement cost, bilateral netting agreements, and add-on factors based on residual maturity for Sharī`ah-compliant hedging contracts (e.g. FX and profit rate). Islamic banks may use the applicable market accepted standard agreements such as the ISDA/IIFM Tahawwut master agreement (TMA).

12 Concluding Remarks 12 The growth, and increasing systemic importance of Islamic banks necessitates effective risk management, regulation and supervision. Regulation and supervision to recognize unique characteristics and instruments. IFSB Standards, complemented by IIFM and AAOIFI standards, are paradigm for prudential regulation of Islamic Banks. In line with the changing international regulatory frameworks, supervisors will continue refining and improving supervisory frameworks for Islamic banks.

13 13 Thank You! Dr. Jamshaid Anwar Chattha, CPIF Chief Banking Researcher and Islamic Finance Expert Off-Site Supervision Department Central Bank of Kuwait

14 14 Key References and Recommended Readings 1. Chattha, J.A. (August 2018). IMF Endorsed IFSB CPIFR - Game Changer for Islamic Finance -, August 2018 Vol 8. No 4, pp 16-21, London, United Kingdom. ISFIRE Review 2. Chattha and Alhabshi (2018). Benchmark rate risk, duration gap and stress testing in dual banking systems. Pacific-Basin Finance Journal Chattha, J. A. (2017). Risk Management and Supervision of Islamic Banks. IMF-METAC Banking Supervision and Regulation Project On Technical Assistance Mission on Islamic Finance for Libya and Gulf University for Science and Technology, Kuwait (November 2017). 4. Chattha, J.A. (Dec, 2017). Fintech and Islamic Finance: A Regulatory Perspective. Wahed Islamic Finance Journal. 5. Chattha, J. A. and Archer, S. (2016). Solvency Stress Testing of Islamic Commercial Banks: Assessing the Stability and Resilience. Journal of Islamic Accounting and Business Research, Vol. 7, No.2, Chattha, J. A., and Alhabshi, S. M (2017). Risk Management in Changing Benchmark Rates Regime: Prudential Implications for Islamic Banks and Supervisors. Journal of Islamic Finance, 6, ISSN Malaysia 7. Chattha, J.A. (June 2016). Risk Management with Stress Testing in Islamic Banks. Islamic Finance Today. 8. Chattha, J. A. and Halim, W. N. (2014). Strengthening the Financial Safety Net: The Role of Sharī`ah-Compliant Lender-of-Last-Resort (SLOLR) Facilities as an Emergency Financing Mechanism. The IFSB Working Paper Series WP/01/3/2014, Kuala Lumpur, Malaysia. 9. Central Bank of Kuwait (2018) - Islamic Finance in Kuwait: Broadening Horizons. 10. IFSB-1 (2005): Guiding Principles on Risk Management for IIFS IFSB-13 (2012): Guiding Principles on Stress Testing For IIFS IFSB-16 (2014): Revised Guidance on Key Elements in the Supervisory Review Process IFSB-17 (2015): Core Principles for Islamic Finance Regulation (Banking Segment). April