Risk Assessment & Regulatory...
Transcript of Risk Assessment & Regulatory...
Risk Assessment & Regulatory Framework In Islamic Banks
The Lebanese Experience
Dr Amine Awad
Executive Director, Lebanon’s Banking Control Commission
Member of the Higher Banking Council
Coordinatior of Basel III Implementation Task Force
Washington D,C. October 18, 2012
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Outline
Preface: What is Islamic Banking
Major Islamic Banking Rules & Standards
Brief History of I.B.’s in Lebanon
Major Regulations for I.B.’s in Lebanon
Liquidity in I.B.’s
Challenges Facing the Development of I.B.’s
List of Islamic Banking Regulations
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Islam encompass all aspects of Muslims life.
Islamic Law or “Shari’a”: derived from the holly Qoran and the Sunna (Practices of the Prophet).
Islamic Financial Model, as seen today, is based on the following 5 major principles:
Principle 1: Everyone involved in a transaction should be well informed
and not misled or cheated.
Principle 2: Islam encourages economic activities but makes a clear
distinction between activities Allowed and activities
Forbidden (Exp: Transactions involving Alcohol, pork,
gambling etc…)
(Cont.)
Preface
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Principle 3: The major Shari’a rule prohibits muslims of “Riba”
(i.e. usury or interest). Islamic Banking has developed
mechanisms that replaced interest income by cash flows
from productive sources (Exp: Profit from trading in assets,
rental income, leasing etc…)
Principle 4: The Islamic Banking Model is based on a Risk and Profit
– sharing (and Loss – bearing); so Shari’a Compliant
transactions are similar to Equity – based Transactions.
Principle 5: Contractual Certainty : Uncertainty or ambiguity that can
lead to disputes render a contract void under Shari’a.
Preface (Cont.)
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Major Islamic Banking
Rules & Standards
As Islam is based on Shari’a, there are 4 major Schools
(Mazahib) of Al – Fikh, i.e. the Interpretation of the Shari’a
Rules, from the extreme rigorous to the easiest:
• MALIKI
• HANBALI
• SHAFI’I
• HANAFI
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Major Islamic Banking
Rules & Standards
In the early 90’s the Islamic Banking Industry decided that the existing International Standards applying to Conventional Banking were inadequate to cater its needs.
In 1991, the AAOIFI (Accounting & Auditing Organization for Islamic Financial Institutions) was created in Bahrain.
Over the years AAOIFI has developed new Standards for Islamic Financial Institutions (I.F.I.) and has taken significant steps to encourage the application and enforcement of its standards.
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Major Islamic Banking
Rules & Standards
AAOIFI objectives are to:
* Develop Accounting and Auditing thoughts for IFI’s
* Disseminate these thoughts
* Preface and Review Accounting and Auditing Standards for
IFI’s, that respect Shari’a.
AAOIFI also created two diplomas for Islamic Banking:
* C.I.P.A. (Certified Islamic Public Accountant)
* C.S.A.A. (Certified Shari’a Advisor & Auditor)
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Major Islamic Banking
Rules & Standards
In 2012, there are:
* 26 Accounting Standards
* 5 Auditing Standards
* 7 Governance Standards
* 45 Shari’a Standards
* 2 Codes of Ethics
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Brief History of I.B.’s in Lebanon
Until February 2004, date of adoption of the Law No 575 on Islamic
Banking, there was no Islamic banks in Lebanon, except one (Al -
Baraka Bank), which was operating as a Conventional Bank,
respecting the shari’a.
Presently there is a small Islamic Banking Sector in Lebanon with 5
Banks, 2 of them are affiliated to large Lebanese Conventional banks
and 3 are affiliated to large Foreign Islamic banks (Bahrani, Qatar &
Iraq).
Lebanon decided to set the legal framework of an Islamic Banking
Sector because of the two following major factors:
Islamic Banking is growing rapidly worldwide (annual growth rate
is estimated at ≈ 15% for the last 7 years)
Excess of Liquidity in the Middle East Region
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Some Figures of the Islamic Banking Sector in
Lebanon
June
2012
2011 2010 2009 2008 2007 2006
5 5 4 4 4 4 4 Number of I.B.
18 18 17 16 13 12 10 Total Number
of Branches
June
2012
2011 2010 2009 2008 2007 2006
920 870 799 771 607 460 340 Total Footings
(Incl. Assets under
Management)
565 534 408 323 269 250 167 Total Deposits
(Restricted +
Unrestricted A/C’s)
129 131 136 134 130 112 112 Total Equity
In USD Million))
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Major Regulations for I.B.’s
→No Islamic Windows are allowed – only Independent Islamic Banks
can offer Islamic banking services and products:
. To put a Chinese wall between Conventional and Islamic Banking and avoid
misleading non – transparent practices.
. To have a clear competitive market for Islamic Finance
→ Minimum Capital for an I.B. is USD 100 Million (with exceptions in
some cases)
→ The 15% cash “Hamesh Al Jaddia” )Margin) is mandatory, in Murabaha
Transactions.(= Margin against Trade Finance Transactions)
→ The legal liability of “Al A’mer Bil Shira’a” )Client) is mandatory in
Murabaha transaction.(including all types of Collaterals)
→ Financing of Real Estate Development Projects (L.T.V.) should not exeed 60% of the project’s value
→ All types of R.E. Intermediation and/or Financing Speculation on R.E. are prohibited
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Major Regulations for I.B.’s
There are many circulars issued by B.D.L. and B.C.C.L. to set the legal and regulatory framework of the various types of Islamic Transactions :
Murabaha (Retail & Trade Finance Transactions)
Musharaka or Mussahama → (Project Financing Transactions)
Ijarah & Ijarah Muntahia Bitamlik (Leasing Transactions)
Mudaraba (Profit sharing between the bank and the Client)
Salam (Advances against Future delivery of assets)
Istisna’a (Advances against manufacturing of an asset to be
delivered to the Islamic Bank)
Sukuk (Bonds) → (Islamic Asset Backed Instruments)
Islamic Mutual Funds
(Cont.)
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On the other hand B.D.L. issued four important Circulars:
- In August 2004, Circular # 94, setting Limit for I.B.’s Investments in R.E. (50% of the Total Investment Portfolio)
- In February 2007, Circular #107, drawing a specific form of Balance Sheet (including Off – Balance Sheet items) and P & L Account for I.B.(B.C.C.L. will issue in the next couple of weeks a Condensed B/S).
- In September 2007, Circular # 112, on Corporate Governance Practices in I.B. :
* Mandating Corp . Gov. Unit (with a Non – Executive Board
Member) (+) Shari’a Audit Unit (reporting to B.o.D. and Shari’a
Board), in addition to other B.o.D Committees (as for Conventional Banks)
* List of Disclosures for full transparency
* Role: - Protect the interests of the customers and other stakeholders
- Supervise and develop the systems relating to Corporate
Governance
Major Recent Regulations for I.B. (Cont.)
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Major Recent Regulations for I.B. (Cont.)
- In May 2008, Circular # 116, on new Capital Instruments (Tier2) in I.B.’s, including:
* Kard Al – Hassan (Subordinated Loan) (Perpetual = i.e. minimum 5 years no capital guarantee, not redeemed except from free distributable profits)
* Cash Contribution (with no return and for the whole life of the Bank)
- In May 2008, Circular # 163, on the pre - conditions to Sell Islamic Financial Products
* I.B. must obtain B.D.L. prior approval to sell any Islamic Financial Product to the public (to avoid misleading and protect consumers of Islamic financial services)
- In July 2008, Circular # 178, on Investments of I.B.:
* Total Lending of I.B.’s to their Affiliated Companies, should not exceed 30% of the bank’s Equity )and 10% per company)
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Methodology of Regulation /
Supervision of I.B.’s
- Joint Task Force (Between B.D.L. and B.C.C.L.) specialized in Islamic Banking that sets the Legal and regulatory framework of the I.B. Activities ( Mainly: Capitalization, Provisionning, Risk Management Approach, Int. / Ext. / Sharia’a Audit etc…)
- On – Site Examination Team, specialized in Sharia’a Compliant Banking Transactions.
- B.D.L. and B.C.C.L. are in the process of preparing a “Consolidated Balance Sheet” between a Conventional Bank and an Islamic Bank, that respects IAS/IFRS as well as IFSB/AAOIFI Standards:
* Because some Lebanese Conventional Banks have an
Islamic Subsidiary in Lebanon
* Some others have an Islamic Subsidiary abroad
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Liquidity Management In I.B.’s
In addition to the methodology of Management of
Liquidity in Conventional Banks, many specific ratios
are used to measure the liquidity in I.B.’s; the most used
by the I.I.R.A. (Islamic International Rating Agency)
are:
LR (1) = Liquid Assets (a)
Liquid Liabilities (b)
LR (2) = Liquid Assets
Total Liabilities
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Liquidity In I.B.’s
LR (3) = Loans
Core Funding (c)
LR (4) = Interbank Borrowings
Total Assets
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Definitions of Liquidity Elements
(a) Liquid Assets of I.B.’s = Cash + Cash Equivalent
+Placements with Banks & F.I.’s +Liquid Investments
(b) Liquid Liabilities in I.B.’s = Deposits + Borrowings
from Bank & F.I.’s
(c) Core Funding in I.B.’s = Deposits + Capital –
Investments in Affiliates – Investments in Fixed Assets
– Large Deposits (> 5% of Equity) – Reserves with
Central Banks
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Liquidity In I.B.’s
In a recent study (published in 2009), made by 4 experts
on the “Financial Performance of Malaysian I.B.’s v/s
Conventional Banks”, the authors reached the following
conclusion:
Average of Net Loans to Total Assets ratio for Islamic
banks stood at 45.2%, which is lower than Conventional
banks (57.1%). This means that Islamic banks are more
liquid than Conventional banks.
The Financing to Deposit Ratio for Islamic banks (49.2%)
is lower than Conventional banks (68.1%) by 18.9%, this
indicates that Islamic banks are more liquid than
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Liquidity In I.B.’s
Looking at these ratios, we could say that Islamic banks
seem to have better liquidity ratios in comparison to
Conventional banks.
According to Haron (2004) Islamic banks experienced
excess liquidity given the lack of Islamic Financial
Instruments in the market for the Islamic bank to invest
in. Besides, the lower assets tied to net loans of Islamic
banks compared to Conventional banks which resulted
in higher liquidity may be due to the stringent financing
policy (i.e. must comply with Shari’a unlike the
Conventional banks).
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Comparative Liquidity in I.B.’s v/s C.B.’s
(Malaysia)
Liquidity I.B.’s C.B.’s
Net Loans / Tot Assets 45.2 57.1
Net Loans / Dep & ST Funding 49.2 68.1
Net Loans / Tot Dep & Borrowings 48.8 66.0
Liquid Assets / Dep & ST Funding 45.1 30.4
Liquid Assets / Tot Dep &
Borrowings
44.7 28.5
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3 Liquidity Ratios (in I.B.’s)
Level 1 (on-B/S)
=(Cash + Central Bank + Nostro Banks + Murabaha with Central Bank + Murabah with Banks
(B/S) - Vostro Banks -Banks Unrestricted investment accounts) / (current accounts including
margins on LC's & Hamish Jaddiyya + Sundry Creditors)
Level 2 (on-B/S & off- B/S unrestricted murabaha with banks)
= (Cash + Central Bank + Nostro Banks + Murabaha with Central Bank+ Murabah with Banks
(B/S) + Murabaha with Banks unrestricted-Vostro Banks -Banks Unrestricted investment accounts)
/ (current accounts including margins on LC's & Hamish Jaddiyya + Sundry Creditors +
Unrestricted Investments Accounts + Profits to be distributed on unrestricted investments accounts)
Level 3 (on-B/S & off-B/S unrestricted & restricted murabaha included)
= (Cash + Central Bank + Nostro Banks + Murabaha with Central Bank + Murabah with Banks
(B/S) + Murabaha with Banks unrestricted+ Murabah with Banks Restricted-Vostro Banks -Banks
Unrestricted investment accounts -Restricted Wakala (banks)) / ( current accounts including margins
on LC's & Hamish Jaddiyya + Sundry Creditors + Unrestricted Investments Accounts + Profits to
be distributed on unrestricted investments accounts + restricted Investments Accounts + profits to
be distributed on restricted investments accounts))
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Challenges Facing the Development of I.B.
1) Shari’a Arbitrage: as the Regulator / Supervisor is not in a position to assess the suitability of the different scholars consulted by the Islamic Banks. However the references are the I.F.S.B. (Islamic Financial Services
Board) Principles and the AAOIFI Standards
2) Absence of Capital Adequacy Standard: for I.B’s )Basel II & Basel III)
3) Human Resources: There is a shortage of experienced professionals in the Islamic Financial Sector. This needs more education and trainings.
4) Contracts & Documentation Risk: Equivalent to the Legal Risk in Conventional Banks.
If a transaction reveal to be Shari’a non – compliant, the Asset can be converted into liability in the Islamic Banks B/S (in addition to the Zakat Penalty)
5) Reputational Risk.
Mainly due to lack of transparency or to wrong presentation of the Islamic products and services and their underlying risks.
P.S. The B.C.C.L. Try to apply the Risk Identification, Assessment and Quantification in I.B.’s under the Pillar II.
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List of Most Important Islamic Banking
Rules in Lebanon
BDL Circular # 94, dated August 2004: Practice of
Islamic Banking in Lebanon
BDL Circular # 95, dated August 2004: Conditions of
Establishment of an I.B. in Lebanon
BDL Circular # 96, dated October 2004: MURABAHA
BDL Circular # 97, dated January 2005 & BCCL Circular
# 246 :MUSHARAKA (or MUSSAHAMA)
BDL Circular # 98, dated June 2005: Islamic Collective
Investment Schemes
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List of Most Important Islamic Banking
Rules in Lebanon
BDL Circular # 99, dated June 2005 & BCCL
Circular # 247: IJARAH & IJARAH
MUNTAHIA BITTAMLEEK
BDL Circular # 100, dated July 2005 & BCCL
Circular # 249: MUDARABA
BDL Circular # 101, dated December 2005 &
BCCL Circular # 253 : BAI’ SALAM
BDL Circular # 102, dated December 2005 &
BCCL Circular # 254: ISTISNAH
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List of Most Important Islamic Banking
Rules in Lebanon
BDL Circular # 107, dated February 2007: I.B. Financial Statements
BDL Circular # 112, dated September 2007: Corporate Governance in I.B.
BDL Circular # 116, dated May 2008: Capital Instruments in I.B.
BDL (Intermed.) Circular # 163, dated May 2008: Islamic Financial Products
BDL (Intermed.) Circular # 178, dated July 2008: Limit for I.B.’s lending to their Affiliates
P.S: Central Bank Website: www.bdl.gov.lb
Banking Control Commission Website: www.bccl.gov.lb