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OVERSIGHT & RISK MANAGEMENTHizamuddin Jamalluddin
Head, Strategic Planning-Managing Directors’ Office
Strictly Private & Confidential
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BOARD OF DIRECTORS
SHARIAH SUPERVISORY COUNCIL
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SHARIAH GOVERNANCE FRAMEWORK
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SHARIAH AS OVERARCHING PRINCIPLE IN BANK ISLAM
SHARIAH SUPERVISORY COUNCIL (SSC)
•Oversight accountability on Shariah related matters.
BOARD OFDIRECTORS
(Overall oversight on Shariah governance structure & Shariah
compliance) BOARD RISK COMMITTEE
AUDIT & EXAMINATION
COMMITTEE (AEC)
MANAGEMENT•Ensure execution of business & operations are in accordance with Shariah principles.• Provide necessary resources, infrastructure, enablers to the SSC.
Shariah Risk Management Control Function:Identify, measure, monitor, report & control Shariah non‐compliance risk
Shariah Review Function:Review business operation on regular basis to ensure Shariah compliance.
Shariah Research Function:(under Product Development)Conduct in‐depth Shariah research prior to submission to Shariah Committee.
Shariah Audit Function:Provide independent assessment & objective assurance designed to value add & improve Bank Islam adherence to Shariah
BOARD GOVERNANCE PRINCIPLES
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Risk Identification, Assessment, Control,
Monitoring & Reporting
Independent Risk Control & Segregation of Duties
Information & Communication
Monitoring & Remedial/ Corrective Action
Risk Management Oversight
OVERSIGHT STRUCTURE
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MANAGEMENT COMMITTEE (MANCO)
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MANAGEMENT RISK CONTROL COMMITTEE (MRCC)
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INTEGRATED FRAMEWOK
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Board of DirectorsSet Risk Appetite & Tolerance Level
Board Risk Committee
Management Risk Control Committees
[Present single view of risks and to ensure adequate policies and control]
MRCC ALCO ORCC RMC BARC
Risk Management Division
Credit Risk
Management
Market Risk
Management
Operational Risk
Mgmt
Monitoring & Reporting
Business DivisionConsumer BankingCorporate Inv. BankingCommercial BankingTreasury
Operation DivisionBranchesCash ManagementCorp. Communication
Business Support Div.Credit AdministrationTransaction ServicesTrade Operations
Other Div.Information Tech.Product Dev.Human Resourceetc
Risk Policies & Capital Allocations
Feedback from Audit & Examination Committee
RISK POLICY METHODOLOGY
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GOVERNANCE ARCH– THREE LINE OF DEFENCE
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1st line of defense 2nd line of defense 3rd line of defense 1st line of defense 2nd line of defense 3rd line of defense
Touch PointsBusiness Units (Point of Origination)Business SupportsOperationsProduct Development
Touch PointsBusiness Units (Point of Origination)Business SupportsOperationsProduct Development
Risk Management(Credit, Market & Operational Risk)Shariah ReviewShariah Risk ManagementCompliance
Risk Management(Credit, Market & Operational Risk)Shariah ReviewShariah Risk ManagementCompliance
Internal AuditShariah AuditInternal AuditShariah Audit
RISK MANAGEMENT ROADMAP
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MaximiseEarningsPotential
EarningsStability
ProtectionAgainstUnforeseenLosses
Increased Risk Management Sophistication
Risk IdentificationRisk Management/AssessmentRisk ReportingProcesses & ProceduresRMS(datamart, credit risk, Basel II)
Loss Minimization/Risk Control Framework
Risk‐based product pricingLinking risks and returnsMeasuring risk adjusted performanceIntegration of market, credit and operational risksRMS(market, operational)
Economic capitalRAROCBank‐wide VaRIncremental VaRRMS(economic capital, RAROC, IRB)Full compliance with Pillar 2
RAPM Framework
Active Portfolio ManagementFramework
Reactive
Active
Proactive
RISK MANAGEMENT STRATEGIES
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RISK IT ENABLER
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ERP‐Systems Other Risk Systems >>EDW
Data‐Management – Data Quality, Data Models and Flows
Reporting
Source Systems
RISK CULTURE
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Most important element in a bank!
“The norms and traditions of behavior of individuals and of groups within an organization that determine the way in which they identify, understand, discuss and act upon the risks the organization confronts and the risk it takes”
Horizontal information sharing
Vertical escalation of threats or fears
Continuous and constructive challenging of the organization’s actions and preconceptions
Committed leadership
Incentives that reward thinking about the whole organization
QUALITY OF RISK MANAGEMENT IN ISLAMIC BANK
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Mgmt Board Oversight Senior Mgmt Risk Mgmt Compliance
Embed Shariah rulings into operational procedure
Refer to the SSC for any
operational issues during
implementation
Observe and implement
Shariah rulings and decisions made by SSC in the day‐to‐day operation
Ultimate accountability on‐Shariah governance
framework & Shariah compliance
BOD members have basic knowledge in
Shariah
Interaction with SSSC members (Appoint 1 SSC member on the BOD or Provide
forum for interaction
Oversee audit and review on Shariah
matters
Assisted by SC :• Provide rulings on Shariah matters• Oversee implementation of Shariah matters•Advice the Board• Endorse policies & procedures and documentations
Implement rulings by SSC
Identify Shariah issues and refer to
SSC
• Endorse that new product approval has :‐Complied with internal product design and pricing policy, and reflect its strategy‐ Been endorsed by the Shariah Committee that it complies with Shariah rulings and SAC resolution‐ Taken into account all the inherent risks and the mitigation
Shariah risk is assessed as part of the Operational and
Legal risks
Identify, measure, monitor, report & control Shariah non‐compliance risk
Develop and implement processes for Shariah non‐
compliance risk awareness
Shariah risk management
function is to be performed by risk officers that have
suitable qualifications
Internal Audit
Provide independent assessment &
assurance on IFI’s compliance with
Shariah
Shariah audit to be performed by
internal auditors that have acquired adequate Shariah‐related knowledge
The audit shall cover:‐ Financial stmts ‐ Compliance of the structure, people, process and systems‐ Adequacy of Shariah governance
Review business operations on regular basis to ensure Shariah compliance
Examine Level of compliance, the rectification
measures and the control mechanism
to avoid recurrences
Cover overall business operations
(including end‐to‐end product development process)
Source: Mohamad Muhsin Mohd Anas, Bank Negara Malaysia
ENTERPRISE WIDE RISK FOR ISLAMIC BANKS
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RISK PROFILE OF ISLAMIC BANK
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Financial RiskFinancial Risk Business RiskBusiness Risk Treasury RiskTreasury Risk Governance RiskGovernance Risk
Credit RiskCredit Risk
Market RiskMarket Risk
Equity RiskEquity Risk
Operational RiskOperational Risk
Solvency RiskSolvency Risk
ALM RiskALM Risk
Hedging RiskHedging Risk
RoR RiskRoR Risk
Reputation RiskReputation Risk
Transparency Risk
Transparency Risk
Shariah RiskShariah Risk
Fiduciary RiskFiduciary Risk
Iqbal, Mirakhor: Introduction to Islamic Finance, theory and practice
FINANCIAL RISK
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CREDIT RISK – INTERNATIONAL BEST PRACTICE
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IFSB-1 PUBLISHED STANDARD
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CREDIT RISK MANAGEMENT
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Feedback Loop
CREDIT GOVERNANCE STRUCTURE AT BANK ISLAM
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BusinessBusiness Credit Risk AnalysisCredit Risk Analysis
Financing Committee AFinancing
Committee AFinancing
Committee BFinancing
Committee B
Underwriting and Investment Committee
Underwriting and Investment Committee
Board Financing Committee
Board Financing Committee
CRO
Board Risk CommitteeBoard Risk Committee
RISK ASSOCIATED WITH SHARIAH CONTRACTS
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IJARAH In case of a non‐binding Ijarah, the Bank runs the risk of having to sell the asset at a (much) lower price. Bank also runs the risk of residual value at end of the lease.
Normal credit risks with respect to periodical payments of installments.
Bank is responsible for major maintenance costs
Legality and enforceability of the beneficial ownership
AssetAsset
CustomerCustomer
Fund Flow
RISK ASSOCIATED WITH SHARIAH CONTRACTS…CONT
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COMMODITY MURABAHAH / TAWARRUQ
Exposed when Bank delivers asset to Customer but does not receive payment on time. Higher risk in non‐binding MPO.
The sequence of the ownership transfer of asset and the fact that 2 traders are involved could expose the Bank to price risk.
Operational risk ‐ Broker defaults in the middle of the transaction
Normal credit risks of non‐payment or not according to contract during the life of the transaction
CustomerCustomer
Commodity Trader 1
Commodity Trader 1
Commodity Trader 2
Commodity Trader 2
Asset/Commodity Flow
Fund Flow
1 3 5 6
2 4
RISK ASSOCIATED WITH SHARIAH CONTRACTS…CONT
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MUDHARABAH FINANCINGPrincipal – Agent problems; Adverse selection by Customer (info asymmetry)
Risk especially high when info asymmetry is high and in cases of low transparency (in case Bank does not have appropriate rights to monitor participate in management of project)
In case if misconduct/negligence of customer, Bank’s share of capital is transformed into debt liability (different rules apply to recovering debt)
Higher capital credit charge
CustomerCustomerBusiness Venture / Project
Business Venture / Project
Fund Flow
ProfitProfit LossLoss
PSR
PSR
X%
1‐X%
RISK ASSOCIATED WITH SHARIAH CONTRACTS…CONT
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SALAM / ISTISNA
Bank is exposed to failure of customer to supply on time or at all, or if specifications of goods/project are not according to agreement. Hence payment could not be secured by selling commodities or project.
Bank usually enter into parallel Salam/Istisna, but contracts must not be linked. Hence if one leg falls away, the bank is still liable to perform under the other leg.
Customer(Today)Customer(Today)
Customer(delivery)Customer(delivery)
Asset/Commodity Flow
Fund FlowJeroen P.M.M Thijs, CRO‐Bank Islam, Credit Risk Management in Islamic Banks
TREASURY RISK
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RISK MANAGEMENT AT TREASURY
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Issuer’s/Counterparty Rating•Reliance on ECAIs•Govies vs PDS;AAA vs BBB•Probability of default ;rating downgrades
Underwriting activitiesCommitment to underwrite; ability to sell down
Adequacy of Internal market risk measure‐duration, PV01, VaR, Net Open Position
ConcentrationBy type of securities, sectorial, by rating, geographical location
Market Environment • Sector outlook;•Developments impacting specific issuer/counterparty
Supervisors to consider circumstances when credit risk becomes primary risk:‐Portfolio dominated by banking book securities‐Business strategy to trade on credit of the instruments
Peculiarities of Islamic Banking• Understanding of securities structure and underlying contracts is essential for the assessment of source of repayment• To rely on rating by ECAI, supervisors should ensure that assessments by ECAI had covered all the unique characteristics of the underlying Islamic contract
MARKET RISK – FACTORS TO CONSIDER
Role in market –principal dealer;
market maker; hedge provider
Concentration to specific market – over
the counter, derivatives or foreign
exchange
Nature and characteristics of positions – longer maturity structure; exotic currencies
Peculiarities of Islamic Banking• Valuation and price volatility of non‐
traditional banking assets (e.g. commodities, real estate, vehicle/automobiles)
Market Liquidity Risk•Immediate – speed of sale & cost to bear•Market Resilience•Market Depth•Breath – bid and ask spread
Funding Liquidity Risk• Maturity Transformation – Long term lending vs short term funding•Wholesale vs retail funding•Undrawn loans and crystallization of guarantees
LIQUIDITY RISK – FACTORS TO CONSIDER
Source: Mohamad Muhsin Mohd Anas, Bank Negara Malaysia
RISK MANAGEMENT – BUSINESS BANKING
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Financing structure•Type of financing – bullet principal payment, long moratorium, RC (rollover of profit portion), Longer tenure financing, unsecured exposures, large working capital
Resources – supported by adequate number of staff with necessary
experience
ConcentrationBy sectors, by rating, geographical location, major borrowers (ie. Top 20)
Market Environment • Sector outlook; Developments impacting specific borrowers
Portfolio Analysis• Identify risk drivers ‐ vulnerable sectors, rating distribution• Delinquency analysis•Concentration analysis•Post‐mortem & Post‐approval Credit Review
OPERATIONAL RISK – FACTORS TO CONSIDER
IT system Infrastructure and MIS – ability to
support corporate banking business and
risk monitoring function
Manual Intervention–extent of manual
processes and internal control
Legal & regulatory risk• Assess financing structure, detailed scrutiny of
security documents•Nature and extent of business activities, including
new products and services;•Volume and significance of non‐compliance and non‐conformance with P&P, laws, regulations
Strategic Risk•Inability to implement business plans and strategies•Resources constraints to support business plan•Inability to adapt to changes in business environment•Stiff competition/pricing issues•Difficulty in growing business due to low risk appetite
STRATEGIC RISK – FACTORS TO CONSIDER
Shariah Risk – lapses in Shariah Compliance
RISK MANAGEMENT – RETAIL BANKING
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Robustness of Credit Underwriting Standards
Comprehensiveness of risk appetite statement• Loss tolerance level•Target market/customer segment•Portfolio mix/concentration
Transaction Volume
Risk Profile•Concentration to risk drivers‐income, MoF, LTV employment, age etc
Business Targets• Financing growth, PBT target, incentive scheme
Impact of Economic Condition•:GDP growth/contraction;•Unemployment rate•Inflation
Adequacy of Risk Management ToolsPortfolio analysis‐• Migration Analysis/Flow Rates•Vintage Analysis•Scorecard Analysis•Performance of Deviation Cases•Assets Quality Trend (Delinquencies & impaired)•Performance of Reschedule & Restructured Accounts
OPERATIONAL RISK – FACTORS TO CONSIDER
Internal ControlAdequacy of check and balance function across retail credit processes
IT Infrastructure– capacity & capability of systems to support retail banking operations and risk management
function
Shariah Issues‐documentations and
Aqad
External Events –Catastrophes, fraud, AML
Debt‐service‐ratio – to be net of all statutory deductions and other obligations which are not covered by Central Credit Reference Information System (CCRIS)
Tenure – Vehicle financing must not be more than 9 years
MACRO PRUDENTIAL MEASURES ON RETAIL BANKING
Product Complexity
Segregation of duties
Marketing – Disclosure requirements; Fess and charges
Tenure – Vehicle financing must not be more than 9 years
AKPK – Avenue for redress & assistance
Sustainability of Residential Property Market•Individual : Maximum LTV of 70% for 3rd
residential properties•Non Individual : Maximum LTV of 60% for residential properties•Other pecuniary costs to be included in LTV calculation except for MRTT/Takaful•To verify existing commitment with CCRIS
CAPITAL MANAGEMENT
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BASEL II
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INTERNAL CAPITAL ADEQUACY ASSESSMENT PROCESS
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Measurement of risk and required capital under BIS2
Integration of risk and capital in
strategic decisions and planningPillar 1 risks Pillar 2 risks External factors
Risk governance and control
Credit risk data issues
Market Risk
Market risk data issues
BIS1
Credit risk
Model risk
Legal risk
Interest rate risk bank book
Liquidity risk
Business risk
Strategic risks
Country & transfer risk
Concentration risk
Operational Risk
Stress tests / scenarios
Macro-economic risks Risk based pricing
Risk adjusted performance management
Active credit portfolio and capital
management
Business planning and budgeting
Risk appetite / capital management
Coherence of risks and results (EL vs LLP)
Roles and responsibilities•Supervisory Board•Executive Com.•Internal audit•Risk Department•Finance Dept•Strategic Planning•Investor relations•Branches
Risk governance•Committees•Limit system•Reporting•Escalations
Minimum standards for risk•Independent internal control•Sound risk assessment•Risk disclosure
Risk Issues Finance Issues Corporate Governance
ICAAP
www.bankislam.com.my
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& Thank You
شكرا جزيال شكرا جزيال
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representation or warranty, express r implied, is given by or on behalf of the Bank as to the accuracy of the information or opinions contained in this presentation. The presentation does not constitute or form part of an offer, solicitation or invitation of any offer, to buy or subscribe for any securities , nor should it or any part of it form the basis of, or be relied in any connection with, any contract, investment decision or commitment whatsoever. The Bank does not accept any liability whatsoever for any loss howsoever arising
from any use of this presentation or their contents or otherwise arising in connection therewith.