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    IFSB Outlines Measures to Ease Impact of COVID for Islamic Banks

    July 08, 2020

    IFSB published two statements addressing the implications of COVID-19 on certain elements of Islamic banking and Islamic capital markets. The statement on Islamic banking aims to clarify the treatment of payment moratoria, the expected credit loss (ECL) approach, and profit-sharing investment accounts, in line with the Sharīah rules, principles, and guidance issued by IFSB and other international standard-setters. The Islamic capital markets statement highlights areas for greater regulatory vigilance and appropriate regulatory responses across IFSB member countries to mitigate the negative economic effects of the COVID-19 pandemic. IFSB will continue to assess the implications of the pandemic on Islamic banking, Islamic capital markets, and Islamic insurance and will issue further public statements where necessary. IFSB also announced that its first COVID-19 Executive Program for 2020 will be conducted virtually on July 07, 2020. The executive program aims to discuss the impact and policy approaches related to COVID-19 across the Islamic banking, insurance, and capital markets sectors.

    Treatment of Payment Moratorium

    Payment moratorium period related to the COVID-19 pandemic can be excluded from the counting of days past due in determining exposures, as prescribed under section 3.1.5 of the revised capital adequacy standard for the Institutions Offering Islamic Financial Services. Another criterion to be considered by the Institutions Offering Islamic Financial Services is the likelihood of customers not meeting their financial obligations. In this regard, for customers that are not making payments in accordance with a payment moratorium, the assessment should be based on the likelihood of payment of the amount due after the moratorium period ends. In determining the risk-weighted assets of the Institutions Offering Islamic Financial Services, regulatory and supervisory authorities should prescribe appropriate risk-weights to reflect the Sharīah-compliant government guarantees and other risk-sharing mitigation measures introduced by authorities in dealing with the COVID-19 pandemic.

    Expected Credit Loss Accounting

    Payment moratorium and Sharīah compliant government guarantees on financing exposures have impact on credit risk as well as the calculation of the ECL, as provisioned in the IFRS 9 and the Financial Accounting Standard (FAS)-30 of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). In view of this, IFSB recommends the following approach to guide regulatory and supervisory authorities:

    • Based on the best available information, the assessment of ECL may consider the temporary nature of the virus impact and incorporate relevant fiscal support measures. A range of scenarios, including the downside scenario in the current situation, could also be used to support credit risk analysis. Institutions Offering Islamic Financial Services are expected to review the status of the exposures and the ability of the customer to resume payment after the moratorium period.
    • Disclosure requirements related to the transitional arrangements remain unaffected where the Institutions Offering Islamic Financial Services would need to disclose whether a transitional arrangement is applied and to disclose the impact on an institution's regulatory capital and leverage ratios compared to the “fully loaded” capital and leverage ratios, had the transitional arrangements not been applied.

    IFSB takes cognizance of the April 2020 guidance from BCBC on the transitional arrangements for the implementation of ECL model in light of the ongoing crisis and adopts similar measures. Jurisdictions that follow the transitional arrangements for the ECL accounting as prescribed by BCBS may consider the following the amendments to the existing transitional arrangements for the regulatory capital treatments of ECLs:

    • Jurisdictions may apply the existing transitional arrangements, even if they were not initially implemented when the Institutions Offering Islamic Financial Services first adopted the ECL model.
    • Regulatory and supervisory authorities may permit the Institutions Offering Islamic Financial Services to switch from the static approach to the dynamic approach, to determine the transitional adjustment amount (even if they have previously switched the approach that they use). 
    • In addition to the two existing approaches to calculate the transitional adjustment amount, jurisdictions may use alternative methodologies that aim to approximate the cumulative difference among provisions under the ECL accounting model and provisions under the prior incurred loss accounting.
    • For transitional arrangements covering the two-year period comprising 2020 and 2021, jurisdictions may choose to allow the Institutions Offering Islamic Financial Services to add-back up to 100% of the transitional adjustment amount to common equity tier (CET1). The “add-back” amount must then be phased-out on a straight-line basis over the subsequent three years.

    Profit-Sharing Investment Accounts 

    The Institutions Offering Islamic Financial Services that offer unrestricted investment accounts and maintain a profit equalization reserve (PER) and/or an investment risk reserve (IRR) may utilize or draw down these reserves for profit smoothing (through PER) or absorption of losses (through IRR), including in these trying economic conditions due to the pandemic. Other Institutions Offering Islamic Financial Services, which maintain neither reserve, may continue to adhere to the terms of contracts with investment account holders in relation to the bearing of losses. Maintaining these arrangements during times of stress and uncertainty would also require regulatory and supervisory authorities to stress the need for transparency as well as appropriate and timely disclosures by the Institutions Offering Islamic Financial Services to their investors. In this regard, IFSB recommends for the disclosure to cover material information related to the impact of the current crisis on the investment strategies and decisions, investment profitability and investment risks, utilization of PER and IRR, and transfers to profit-sharing investment accounts profits from shareholders’ funds (if any) on the basis of unconditional support. 

    Recommendations for the Islamic Capital Markets

    Capital market regulators may emphasize the importance of providing appropriate information in good time to clients or potential clients, with regard to the firm and its services and the Sharīah-compliant financial instruments offered so that clients can make informed investment decisions. In relation to the Sharīah-compliant listed companies in a jurisdiction, to ensure adequate transparency and disclosure during extraordinary circumstances, regulators may emphasize the need to assess and disclose the operational impact of COVID-19 on the company performance. The Islamic capital markets statement also provides recommendation on the topics related to suitability and appropriateness requirements, cyber risk management, client assets, handling investor complaints, and investor education and investor alerts.

     

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    Keywords: International, Banking, Insurance, Securities, COVID-19, IIFS, Islamic Banking, Shariah, ECL, IFRS 9, Credit Risk, Basel, Loan Moratorium, BCBS, IFSB

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