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5.5 Integration of Liquidity Risk into Enterprise Risk Management Framework

C 33/2015 STA يسري تنفيذه من تاريخ 3/1/2022
  1. a.IB must ensure that liquidity risk management practices are incorporated within an institution-wide, integrated enterprise risk management framework that fully takes into account the interactions between liquidity risk and other risks, including market, credit and operational risk, displaced commercial risk, reputational and Shari’ah non-compliance risk, as per the Central Bank’s risk management regulations and standards. This framework must also address liquidity risk arising from various Shari’ah-compliant financial contracts, either directly due to the nature of the contract or indirectly as a consequence of other risks, at any stage during the period of the contract.
  2. b.IB must take into account the fact that various types of risks interact with liquidity risk in a variety of ways, both in normal and stressed conditions.
  3. c.Credit risk in an IB can transform into liquidity risk if it faces major defaults in its financing and investment portfolio. Uncertainty about the creditworthiness and quality of an IB’s financing portfolio can make it difficult to obtain funding from the market or to resell an eligible asset portfolio to other IBs. For instance, Murabahah and other debt modes of financing cannot be resold in the market due to Shari’ah restrictions on the selling of debt. In addition, during stressed conditions, an IB may find it difficult to sell or collateralise these assets to generate liquidity. Furthermore, any reputational problem experienced by the IB due to perceived Shari’ah non-compliance or fiduciary risk may result in the withdrawal of funds by the fund providers, resulting in heightened liquidity risk for the IB.
  4. d.The liquidity risk management framework of the IB must factor-in these and similar relationships and interactions between liquidity risk and other risks while setting limits, performing stress testing, preparing CFP, and executing its risk management strategy and policies in its operational environment.
  5. e.Rate of return risk, which is a major cause of displaced commercial risk, can also give rise to liquidity problems in the IB. For instance, IBs may have invested investment accounts’ funds into relatively long maturity assets such as long-maturity Murabahah, Ijarah without repricing, and thereby have locked in lower rates of return on assets than those currently on offer in the market. Despite the contractual features of the investment accounts, the investment account holders may choose to move their funds to other institutions offering higher return, posing a liquidity risk for the IB. To mitigate this risk, IB may smooth the profits payout to their IAH.
  6. f.IB must address liquidity risks arising from various Shari’ah-compliant modes for financing and investment. IB must especially look into risk transformation in the transactions during the various stages of execution, which might impact the liquidity of these products, directly or indirectly.
    1. i.In a Murabahah contract, an IB’s liquidity is impacted by the risk of cancellation in a non-binding Murabahah contract and by late or non-payment by customers.
    2. ii.In the case of Ijarah, IB may face liquidity risk due to the late or non-payment of instalments by the customer, the inability to sell or lease the asset to a new customer at the end of an earlier contract, or default by the customer.
    3. iii.In a Salam contract, the illiquidity of commodity markets and the non-permissibility of exiting the contract before delivery can pose a liquidity risk for an IB.
    4. iv.In the case of the investment modes, Mudarabah and Musharakah, liquidity risk can arise in the case of late or non-payment of profit payments during the contract and non-payment by the customer of the principal at the end of the contract.
  7. g.The IB must be able to analyse its financing and investment portfolio with reference to features of Shari’ah-compliant contracts that can lead to liquidity risk and make appropriate adjustments, as needed. Overall liquidity risk for an IB will largely depend on the mix of various Shari’ah-compliant modes of financing and investment in its asset portfolio and the concentration of individual customers exposed to each type of contract.
  8. h.The IB must take into consideration that liquidity risk can arise either directly due to the nature of the contract or indirectly as a consequence of other risks at any stage during the period of the contract, mostly through credit risk, whereas continuous illiquidity in the Sukuk market mostly impacts an IB’s liquidity through market risk.
  9. i.An IB must be able to take fully into account the interaction between funding and market liquidity in its analysis of liquidity risk. With the increasing interconnections between the two types of liquidity, it is imperative that the IB evaluate the potential systemic consequences of liquidity problems.
  10. j.A liquidity risk management framework must include limits, warning indicators, communication and escalation procedures. IB must set limits to control its liquidity risk exposure and vulnerabilities. IB must regularly review such limits and corresponding escalation procedures. Limits must be relevant to the business in terms of its location, complexity, and nature of products, currencies and markets served.
    Limits must be used for managing day-to-day liquidity within and across lines of business and legal entities under “normal” conditions. The limit framework must also include measures aimed at ensuring that the IB can continue to operate in a period of market stress, bank-specific stress and a combination of the two. For example, a commonly used simple limit is the size of cumulative net cash outflow (based on board approved assumptions) and covers various time horizons. The limit may also include estimates of outflows resulting from the drawdown of commitments or other obligations of the bank.