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  • Article (5) Qualitative Requirements

    1. a. This article addresses the qualitative requirements contained in the regulations and emphasises the key focus of the Central Bank in its on and off site examination of IB.
    2. b. The qualitative rules in this Standard come into force on 30 June 2022. Any IB that expects to be in breach of the Regulations and Standard must approach the Central Bank to discuss a remediation plan. Breaches will be dealt with on a case by case basis. The Central Bank will apply proportionality in determining the suitability of some of the more complex requirements for smaller IBs.

    • 5.1 Liquidity Management Framework:

      1. a.IBs must have appropriate governance processes, including Board and Senior Management oversight, in order to identify, measure, monitor, report and control the liquidity risk in compliance with Shari’ah rules and principles, and within the context of available Shari’ah-compliant instruments and markets.
      2. b.The governance structure of an IB must specify the roles and responsibilities of senior management, the Internal Shari’ah Supervision Committee (ISSC), and its functional and business units, including that of the risk management department, with appropriate segregation between operational and monitoring functions.
      3. c.IBs must have in place a sound and comprehensive liquidity risk management framework, integrated into the bank-wide risk management process. The primary objective of the liquidity risk management framework must be to ensure, with a high degree of confidence, that the IB is able to maintain sufficient liquidity to meet its regular funding requirements and payment obligations in the normal course of business; and to help it withstand a reasonable period of liquidity stress based on its liquidity risk tolerance level. The source of funding could be IB specific or market-wide.
      4. d.The liquidity risk management process of an IB must involve adequate tools to identify, measure, monitor, report and control the liquidity risk in compliance with Shari’ah rules and principles, including a plan to meet contingency funding requirements and setting limits on the basis of robust stress testing and scenario analysis.
      5. e.The Board bears the ultimate responsibility for approving a comprehensive liquidity risk management framework, and for monitoring the level of liquidity risk by the IB. This framework must include strategy and robust policies for the management of liquidity risk by the IB, keeping in view the nature, size and complexity of its operations, business model, funding profile, mix of Shari’ah-compliant financing and investment products, and availability of Shari’ah-compliant liquidity instruments and mechanisms.
      6. f.Senior management is responsible for executing and implementing the Board-approved strategy and must develop policies for managing the liquidity risk; for having a clear view of all sources and linkages of liquidity risks by taking a holistic approach to risk management; and for laying down the procedures and processes for continuous monitoring of liquidity risk and reporting to the Board.
      7. g.The strategy and policies of IBs for liquidity risk management must explicitly incorporate both normal and stressed times scenarios.
      8. h.The liquidity risk management framework must cover identifying, mitigating and managing liquidity risk. The IB must ensure that its liquidity risk management function does not take the opportunity to make profits at the expense of prudent management of liquidity risk.
      9. i.Liquidity risk management strategy and policies must cover all on and off-balance sheet items. IB must perform an impact analysis on management and mitigation of liquidity risks arising from new business initiatives and product approvals. The IB must have comprehensive and appropriate internal controls and internal audit mechanisms, in order to evaluate and test the adequacy of controls in the liquidity risk management framework. The senior management must ensure that all such functions and business units are operating under the approved policies, procedures and limits.
      10. j.IBs must have a robust Shari’ah governance framework in accordance with the Standard re Shari’ah Governance for Islamic financial institutions in order to ensure an effective independent oversight of Shari’ah compliance, especially liquidity risk management mechanisms and instruments. The involvement of the ISSC must include the following elements:
        1. i.approving new Shari’ah-compliant liquidity risk management instruments and mechanisms, including Shari’ah-compliant hedging products;
        2. ii.ensuring proper execution of its approved products and mechanisms,
        3. iii.verifying and controlling the non-commingling of funds between Islamic windows/branches/subsidiaries and parent conventional entities; and
        4. iv.ensuring Shari’ah compliance of the IB’s placements with other entities, including placements with conventional banks, if any.

    • 5.2 The Role of the Board

      1. a.The Board has the ultimate responsibility for setting the level of liquidity risk tolerance and the liquidity risk management framework of the IB. The liquidity risk tolerance for the IB must be commensurate with its ability to have sufficient recourse to Shari’ah-compliant funds in order to mitigate this risk.
      2. b.The members of the Board should familiarise themselves with liquidity risk and how it is managed, including IB’s specific liquidity risk. The Board should also understand how other risks affect the IB’s overall liquidity risk strategy, i.e. how a tighter funding market will impact the IB’s liquidity and how other risks, if materialised, could result in a liquidity run on the IB. At least one of the Board members must have detailed understanding of liquidity risk management for Islamic Banks.
      3. c.The Board must ensure that the IB’s liquidity risk tolerance is transformed into actionable elements, reflecting its potential response to a range of plausible events. There are a variety of ways in which an IB can express its risk tolerance. For example, an IB may quantify its liquidity risk tolerance in terms of the level of funding gap the bank decides to assume under normal and stressed business conditions for different maturity buckets.
      4. d.The Board must ensure that liquidity risk tolerance is communicated to all levels of management so that it is taken into account in the various processes of the institution Including, but not limited to product approval, documentation, execution and subsequent monitoring and reporting.
      5. e.The Board must, on a regular basis, and at least on an annual basis, evaluate the relevance of the liquidity risk management strategy and policies based on prevailing and future potential market conditions, ground realities and stakeholders’ expectations while making appropriate changes, as needed. In the case of rapidly changing market conditions related to liquidity, the Board may decide to make appropriate revisions more frequently. The strategy may comprise different high-level qualitative and quantitative objectives, parameters and limits.
      6. f.In line with the stated risk tolerance, the Board must establish, approve and review from time to time, the liquidity risk management strategy and significant policies, taking into consideration the IB’s business model, legal structure, complexity, key lines of business, and macroeconomic and regulatory environment.
      7. g.The Board must ensure that senior management transforms board-approved strategies and policies into detailed and well-documented guidance, procedures and operating instructions which are properly aligned from risk and reward perspectives.
      8. h.The Board must also approve and review the IB’s liquidity contingency funding plan (CFP) established for handling institution-specific or market-wide liquidity stress to ensure that the IB continues to fund its important activities on a timely basis, without incurring unacceptable costs or losses.
      9. i.The Board must establish a mechanism for regular monitoring and detailed reporting of the liquidity risk profile of the IB. It must periodically review this information, and information on the IB’s level of liquidity, in order to be able to provide strategic direction on a timely basis. The Board must have in place a system to review liquidity reports sent to it by management; identify liquidity concerns; and follow up on remedial action undertaken by management.
      10. j.The Board must proactively seek and review information related to any major institutional- and market-level events that could impair the liquidity position of the IB. Institutional-level events may include deterioration in the value and marketability of liquid asset holdings, significant funding concentrations, increasing costs of funding, significant withdrawal of deposits and investment accounts (IA), an escalating funding gap, frequent and sizeable breaches of limits, cash-flow shortages, major losses in operational results, etc. Market-level events may include a rating downgrade or a significant breach in Shari`ah compliance or other breaches, with a potential to transform into increased reputational risk and other negative market events.
         

    • 5.3 The Role of Senior Management

      1. a.Senior management is to develop a strategy, policies and practices to manage liquidity risk in accordance with the Board approved risk tolerance and ensure that IB maintains sufficient liquidity. The strategy should include specific policies on liquidity management, such as:
        1. -the composition of assets and liabilities;
        2. -the diversity and stability of funding sources;
        3. -the approach to managing liquidity in different currencies, across borders; across business lines and legal entities;
        4. -the approach to intraday liquidity management; and
        5. -the assumptions on the liquidity and marketability of assets.

        The IB’s strategy should be continually reviewed and compliance must be reported to the Board on a regular basis.

      2. b.The strategy should take account of liquidity needs under normal conditions as well as under periods of liquidity stress as a result of IB specific or a market wide crises, and a combination of these two. The strategy may include various high-level quantitative and qualitative targets. The strategy should be appropriate for the nature, scale and complexity of the IB’s activities. In formulating this strategy, the IB must take into consideration Shari’ah compliance; its legal structures; key business lines; the breadth and diversity of markets, products, and jurisdictions in which it operates; and the regulatory requirements it is subject to. The Board must approve the strategy and critical policies and practices and review them at least annually.
      3. c.Senior management must ensure that liquidity is effectively managed on a regular and timely basis and that appropriate policies and procedures are established to limit and control material sources of liquidity risk.
      4. d.Senior management must have ongoing and active involvement in order to effectively manage liquidity on a regular and timely basis.
      5. e.IBs must designate responsibility for monitoring and managing liquidity risk to an appropriate committee e.g. the Assets and Liabilities Committee (“ALCO”), the Executive Risk Committee and/or the Risk Management Committee, etc.
      6. f.The ALCO or any other committee assigned to monitor an IB’s liquidity risk must actively monitor the IB’s liquidity risk profile and have adequate broad representation within the IB, including finance, treasury, senior managers, credit, deposits and investments, financing and risk management. The Board must define the mandate of this committee in terms of planning, directing and controlling the flow, level, mix, cost and yield of the IB’s funds and investments.
      7. g.The committee must ensure that the system set up for liquidity risk management is able to adequately identify and measure the risk exposure. The committee must also ensure that the IB has an information system which is sufficiently flexible and able to prepare and provide timely, accurate and relevant reports to senior management, the Board and the Central Bank about the institution’s liquidity risk exposure.
      8. h.Senior management must observe the changes in market conditions and new developments that can present significant challenges in terms of the smooth management of liquidity risk in the IB. Senior management must present to the Board regular reports on the liquidity position of the bank. The Board should be informed immediately of new or emerging liquidity concerns. These include increasing funding costs or concentrations, the growing size of a funding gap, the drying up of alternative sources of liquidity, material and/or persistent breaches of limits, and/or a significant decline in the cushion of unencumbered, highly liquid assets. The Board must ensure that senior management takes appropriate remedial actions to address the concerns. Senior management must be able to recommend to the Board any necessary amendments to the strategy and policies for managing liquidity risk.
      9. i.Senior management is responsible for determining the structure, responsibilities and controls for managing liquidity risk in all legal entities, branches and subsidiaries in the jurisdictions in which IB is active, and outline these elements clearly in the IB’s liquidity policies. The management structure of an IB must be established in such a way that it provides for segregation of duties between operational and monitoring functions, which can minimise the chances of conflicts of interest. It is expected that the primary responsibility for monitoring liquidity risk management must be independent of business units that are involved in the financing, investment and trading functions.
      10. j.It is the responsibility of the Board and senior management to ensure that adequate internal controls and internal audit mechanisms are in place to protect the integrity of the established liquidity risk management process. Senior management must define the specific procedures and approvals necessary for exceptions to policies and limits, including the escalation procedures and follow-up actions to be taken for breaches of limits.
      11. k.The active involvement of senior management is vital to the stress testing process in the IB. Senior management must demand that rigorous stress scenarios be considered, even in times when liquidity is plentiful.
      12. l.The strategy, key policies for implementing the strategy and the liquidity risk management structure must be communicated throughout the organisation by senior management. All individuals within business units conducting activities that have a material impact on liquidity must be fully aware of the liquidity strategy and operate under the approved policies, procedures, limits and controls.
      13. m.Individuals responsible for liquidity risk management must maintain close links with those monitoring market conditions, as well as with other individuals with access to critical information, such as credit risk managers. Individuals with direct responsibility over liquidity risk management at the banks must meet the fit and proper criteria set by the Central Bank including appropriate academic qualifications, good understanding of Shari’ah compliant activities and its liquidity related risks, good character and sound financial position.
      14. n.Senior management must ensure that independent oversight and verification is performed by middle office and/or risk management staff who are capable of assessing treasury’s adherence to liquidity limits, policies and procedures. The independent control functions must have the skills and authority to challenge information and modeling assumptions provided by business lines. In addition, internal audit must regularly review the implementation and effectiveness of the agreed framework for controlling liquidity risk.
         

    • 5.4 Identification of Liquidity Risk

      1. a.IBs must be able to identify the exposure to liquidity risk, in the short and long term, arising from institution-specific, market-wide or cross-border events for all its operations including subsidiaries, branches, or similar arrangements. In the process of identification, the IB must identify and recognise each significant on- and off-balance sheet position that can have an impact on its liquidity in normal and stressed times and establish a range of metrics. The IB must consider the types of events and activities that can expose it to liquidity risk. It must have a robust framework for projecting the contingent liabilities and other commitments, including calculating the impact of drawing on undrawn commitments.

        The identification process must consider, among other things, the nature of exposure, the creditworthiness of the counterparty, correlations between the various business and geographical sectors, and the nature of the relationship with various counterparties. IB must be able to identify incidents that can negatively influence perception in the marketplace about its creditworthiness and the fulfilment of its obligations.

      2. b.IBs must consider the interactions between exposures to funding liquidity risk and market liquidity risk. An IB that obtains liquidity from capital markets and interbank market Shari’ah compliant instruments must recognise that these sources may be more volatile than normal deposits and IAs.
      3. c.An IB must be able to model the contractual and behavioral profiles of its fund providers with respect to normal and disruptive market conditions, which can be impacted by its smoothing techniques. For instance, an IB must ensure the availability of sufficient funds as and when the demand arises from non-remuneration accounts and other accounts guaranteed by IB. In addition, an IB must also model the behavioral profile of its investment accounts, as the IB may be affected by runs or panic withdrawals of funds by the Investment Accounts Holders (“IAH”s) in the case of rate of return risk, Shari’ah non-compliance risk or reputational risk which may have an impact on the liquidity condition of the IB.
      4. d.An IB must ensure that assets are prudently valued according to relevant financial reporting and supervisory standards. An IB must fully factor into its risk management, the consideration that valuations may deteriorate under market stress, and take this into account in assessing the feasibility and impact of asset sales during stress on its liquidity position.
      5. e.In analysing the risk profile of investment accounts, an IB must take into consideration the smoothing techniques adopted by the IB in line with the Central Bank’s standards and regulations. Stress testing, including scenario analysis, must be used to evaluate the behaviour of IAH and other fund providers of the IB and its impact. IB’s own historical data may provide a good basis for performing an internal assessment of the expectations and incentives of IAH, in normal as well as stressed times
      6. f.For restricted investment accounts, an IB normally makes matching investments. However, in the case where restricted investment accounts have the right to withdraw funds before the assets are liquidated, the IB may need to fund the gap for the intervening period until the assets are converted into cash. If the withdrawals are more than expected, the IB may be exposed to liquidity risk.
      7. g.Due to the IB’s dual role in meeting its obligations to current and investment accounts, and managing the expectations of its IAH, it is imperative that the IB performs liquidity cash-flow analysis periodically and under various market conditions. The analysis must include assumptions about the repayment of invested funds to the IAH to the extent that the amount of capital erosion due to investment losses is sufficiently mitigated by Investment Reserve Risk (“IRR”).
      8. h.If the IB is sourcing funds using contracts other than Mudaraba or Wakala, especially if using sale based instruments, such practices will expose the IB to refinancing risk (through renewal of contract) in stressed market conditions. Observing the Shari’ah requirements in such cases, especially Shari’ah rules pertaining to sale of debt which, among other things, requires that renewal of the contract can only be made after the initial contract has been terminated. Counterparties may be less willing to hold their funds with the IB, resulting in a liquidity shortage and possibly a liquidity crisis, especially in the case of stressed markets, as well as perceived or actual financial or reputational problems of the IB.
      9. i.IB must be aware that identification of liquidity risk must take into consideration various liquidity risks associated with its own balance sheet (corporate books) operations. An IB may face funding liquidity problems due to:
        1. i.refinancing risk (e.g. due to system-wide liquidity stress or credit crunch),
        2. ii.the inadequacy of the liquidity infrastructure in the jurisdiction, or
        3. iii.the inability of a particular counterparty to renew a liquidity facility, in the absence of more general liquidity stress.

        Due to the significant size of such transactions and their potential impact on the profitability and liquidity of the institution, IB must monitor the timing, counterparties, nature and terms of transactions (e.g. secured or unsecured), etc.

      10. j.IB must also keep track of information related to significant counterparties and other market related information that can impact, directly or indirectly, the management of its liquidity risk. Such information about significant counterparties, most notably financial institutions, may include, but is not limited to, institutional credit rating, market reputation regarding repayment capacity, share prices, profitability, frequency and capacity to renew the funding, financial results of cross-border operations, credit ratings of issued Sukuk, etc. The market-related information may include Islamic money market rates, profit rates paid to IAH and fund providers by competitors, market indices, latest auction rates of local and sovereign Sukuk, as well as movements in foreign exchange and commodities markets – both in local and cross-border markets.
      11. k.IB must design a set of indicators to aid this process to identify the emergence of increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Such early warning indicators must identify any negative trend and trigger an assessment and potential response by management in order to mitigate the IB’s exposure to the emerging risk. Early warning indicators can be qualitative or quantitative in nature and may include, but are not limited to:
        1. -Rapid asset growth, especially when funded with potentially volatile liabilities.
        2. -Growing concentrations in assets or liabilities.
        3. -Increases in currency mismatches.
        4. -A decrease of weighted average maturity of liabilities.
        5. -Repeated incidents of positions approaching or breaching internal or regulatory limits.
        6. -Negative trends or heightened risk associated with a particular product line, such as rising delinquencies.
        7. -Significant deterioration in the IB’s earnings, asset quality, and overall financial condition.
        8. -Negative publicity.
        9. -A credit rating downgrade.
        10. -Stock price declines or rising debt costs.
        11. -Widening debt or credit-default-swap spreads.
        12. -Rising wholesale or retail funding costs.
        13. -Counterparties that begin requesting or request additional collateral for credit.
        14. -Correspondent banks that eliminate or decrease their credit lines.
        15. -Increasing retail deposit outflows.
        16. -Increasing redemptions of Islamic CDs before maturity.
        17. -Difficulty accessing longer-term funding.
      12. l.Early warning indicators must be closely monitored by senior management on a regular basis. Limits and analysis of the indicators in (l) above must be reviewed and breaches/emerging trends must be escalated up to the board committees or the full board, if significant enough. Clear procedures and escalation criteria must be put in place based on the warning indicators, these include the circumstances where the CFP must be invoked.
         

    • 5.5 Integration of Liquidity Risk into Enterprise Risk Management Framework

      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.
         

    • 5.6 Measurement of Liquidity Risk

      1. a.IB must be able to measure and forecast its future cash flows arising from all of its positions, whether on or off-balance sheet, over a range of time bands. The IB must use a range of time horizons in order to assess its vulnerability to changes in its cash flows and liquidity requirements over time, given the size and mix of its balance sheet components. These time horizons can range from intraday, overnight, weekly and monthly for short-term liquidity assessments, up to one year for medium term and over one year for longer-term assessments.
      2. b.An IB must have robust, documented and well tested methodologies for measuring liquidity risk, and must make appropriate amendments and revalidation to reflect changing market conditions, so as to ensure that the major assumptions and parameters continue to be relevant and up to date.
      3. c.IBs must also take into consideration the impact of potential payments and commitments arising from off-balance sheet items such as committed lines, guarantees, letters of credit and Shari’ah-compliant derivatives. Particular importance must be paid to covenants that trigger the drawing of liquidity lines or that allow counterparties not to fulfil their obligations. Implicit support to restricted investment accounts or any securitisation vehicles of the IB (held off-balance sheet in most cases) must also be considered in the liquidity analysis. For securitisation vehicles, an IB must also take into consideration the contingent exposure and triggering events stemming from its contractual and non-contractual relationships with special purpose vehicles. (“SPV”).
        Undrawn commitments, letters of credit and financial guarantees represent a potentially significant drain of funds for IB. IB may be able to ascertain a "normal" level of cash outflows under routine conditions, and then estimate the scope for an increase in these flows during periods of stress.
      4. d.IBs must recognise that the behaviour of their cash flows can be considerably different from other types of institutions owing to the different nature of the contracts used for their financing and investment products. Cash flows in an IB may be categorised as follows:
        1. i.Known cash flows: are those cash flows where the amount and maturities are known in advance, such as receivables from Murabahah, Ijarah, based financing.
        2. ii.Conditional but predictable cash flows: are dependent on the performance of commitments or work, and fulfilment of agreed terms and conditions over an agreed period by the counterparties, as in the case of Salam, Istisna` and Diminishing Musharakah.
        3. iii.Conditional but unpredictable cash flows: are related to equity participations by the IB where the recovery of invested capital and possible levels of return on investment are conditional on the financial results of the activity in which the funds are invested, as in Musharakah and Mudarabah.
      5. e.For measuring liquidity risk, IB must utilise a range of measurement techniques, time horizons and levels of granularity. Depending upon the nature, size and complexity of operations of an IB, cash-flow forecasts and projections can range from simple spreadsheets to sophisticated modelling techniques, including utilising static simulations, value at risk, liquidity at risk and others. IB may use, for measuring and monitoring liquidity risk, the cash-flow mismatch/maturity gap for calculating the net funding requirement, which is based on an estimation of the amount and timing of future cash flows with respect to contractual or expected maturity.
      6. f.IBs must analyse liquidity gaps, breaking them down by type of product, business unit and currency, with appropriate forecasting of liquidity needs in various stress scenarios. In order to ensure the reliability of the forecasting process, IB must collect and aggregate relevant data, and verify that the data are processed and transferred correctly through various systems and channels. IBs must also validate the forecasted cash flows and ensure that the data are complete and reconciled, with appropriate plausibility checks. The validations and back-testing results must be properly documented and communicated to senior management for their information.
      7. g.The maturity gap approach helps the IB to address the net funding requirement in each time horizon. The analysis of net funding requirements involves the construction of a maturity ladder and the calculation of a cumulative net excess or deficit in funding at a series of points in time.
      8. h.For calculating net funding requirements, the IB must analyse prospective cash flows based on assumptions of the future behaviour of assets, liabilities and off-balance sheet items, and then calculate the cumulative net excess or shortfall over the time frame.
      9. i.Assumptions related to the behaviour of various fund providers and asset classes, or regarding possible triggers of any contingent liability and liquidity disruption, play an extremely important role in measuring and projecting cash flows. IBs must ensure that the assumptions it makes are practical, realistic and properly documented.
      10. j.Assumptions related to the behaviour and stability of investment accounts, current accounts and funds generated from wholesale investors, as well as the volatility of asset portfolios on the basis of investment modes such as Mudarabah and Musharakah, are important. IBs must be able to test various scenarios on the availability of alternative funding sources from Islamic money and capital markets under adverse market conditions, as well as the effects of a deterioration in its asset quality or capital adequacy. An important consideration in such analyses is the critical role that the reputation and creditworthiness of an IB plays in accessing funds from the market on reasonable terms and in time. IB must be aware of any information that may adversely affect its public image and reputation, and hence its access to funds from the Islamic interbank market. Such information includes any negative publicity appearing in the media on the IB’s Shari’ah non-compliance, rating downgrade and fall in earnings.
      11. k.Evaluating the liquidity position and liquidity risk of an IB requires an analysis of the behaviour of different cash flows under various market conditions. This behaviour can be analysed using various stress testing or “what-if” scenarios, to determine what the impact would be on cash stocks (i.e. cash balances) or cash flows. Stress testing helps to quantify potential liquidity gaps in specified stress scenarios using deterministic and stochastic cash flows and, therefore, must be linked with various actions and countermeasures.
      12. l.IBs must also include sensitivity and scenario analyses in their stress testing. While sensitivity analyses test the dependence on a selected risk factor, scenario analyses simultaneously examine the effect of several risk factors on liquidity. The results of stress testing exercises must be the basis of setting limits, preparing the CFP, and revising the strategy, policies and procedures for liquidity risk management in the IB.
      13. m.Stress testing must be conducted on a regular basis and must consider the following:
        1. -It must be done on individual entity basis, group basis and across business lines.
        2. -It must consider the implication of the scenarios across different time horizons, including on an intraday basis.
        3. -The extent and frequency of testing should be commensurate with the size of the bank and its liquidity risk exposures.
        4. -IB must build in the capability to increase the frequency of tests in special circumstances, such as in volatile market conditions or at the request of the Central Bank.
        5. -Senior management must be actively involved in the stress testing process, demanding rigorous assumptions and challenging the results.
        6. -The Board must be informed of the stress testing results and must be able to challenge outcomes, assumptions and actions taken on the basis of the tests.
      14. n.IBs must ensure consistency in the reporting process to allow for comparability overtime and assist in measuring changes in the risk exposure and/or profile.
      15. o.The stress test scenarios must consider the following:
        1. -A simultaneous drying up of market liquidity in several previously highly liquid markets (inter-bank money markets, non UAE funding markets, securitisation).
        2. -Severe constraints in accessing secured and unsecured wholesale funding.
        3. -The run-off of retail funding.
        4. -Contingent claims and more specifically, potential draws on committed lines extended to third parties or the IB’s subsidiaries, branches or head office and the liquidity absorbed by off-balance activities.
        5. -Severe operational or settlement disruptions affecting one or more payment or settlement systems.
        6. -Take into account the link between reductions in market liquidity and constraints on funding liquidity. This is particularly important for IBs with significant market share in, or heavy reliance upon, specific funding markets.
        7. -IBs must also consider the results of stress tests performed for various other risk types and consider possible interactions between liquidity risk and these other types of risk (e.g. capital stress tests), and including consistency across stressed credit and liquidity methodologies/metrics.
        8. -Tests must reflect accurate time-frames for the settlement cycles of assets that might be liquidated (i.e. time to receive the sale proceeds).
        9. -If an IB relies upon liquidity outflows from one system to meet obligations in another, it must consider the risk that operational or settlement disruptions might prevent or delay expected flows across systems. This is particularly relevant for IBs relying upon intra-group transfers or centralised liquidity management.
        10. -Additional margin calls and collateral requirements.
        11. -The availability of contingent lines extended to the IB.
        12. -The impact of credit rating triggers.
        13. -The access to Central Bank facilities.
        14. -The potential reputational impact when executing contingency /remedial action.
        15. -Estimates of future balance sheet growth.
        16. -The likely behavioral response of other market participants (similar response to market stress might amplify market strain).
        17. -The likely impact of its own behaviour on other market participants.
        18. -Where a bank uses a correspondent or custodian to conduct settlement, the analysis must include the impact of those agents restricting their provision of intraday credit.
      16. p.IBs must use various kinds of limits for controlling its liquidity risk. These limits are normally set at the group level and are apportioned downwards to the various entities, including subsidiaries, units/divisions or desks. Through limits, IBs can ensure that it does not have a level of outflows, which cannot be funded in the market, taking account of its risk tolerance and historical record. Overall, IBs must set their limit structure so that it continues to operate in an idiosyncratic stress or market-wide stress, or both.
      17. q.IBs may use internal fund transfer pricing technique for measuring and analysing pricing, profitability and performance of various business lines, products and branches within the IB.

        Since the internal prices affect the performance measurement of different functional units, products and lines of business, senior management must assign such responsibility to an independent unit in a transparent manner. It must also uphold the Shari’ah requirements in case IB has different pools of funds. In addition, the internal pricing must be decided after an interactive discourse between the business lines and the unit/s responsible for the fund transfer price and must cover all significant business activities of the IB, including off-balance sheet. This process must take into account different factors related to assets, liabilities and off-balance sheet items, including their expected holding periods and associated changes in liquidity risk, “stickiness” or stability of funding sources, and other related factors. It must also be updated at appropriate intervals.

      18. r.Senior management must appropriately incorporate liquidity costs, benefits and risks in the internal pricing and performance measurement for all significant business activities (both on- and off-balance sheet). The sophistication of the transfer pricing framework must be in line with the bank’s level of sophistication and business complexity. The costs, benefits and risks must then be explicitly attributed to the relevant activity so that line management incentives are consistent with and reinforce the overarching liquidity risk tolerance and strategy of the bank, with a liquidity charge assigned, as appropriate, to positions, portfolios, or individual transactions.
      19. s.This assignment of liquidity costs, benefits and risks must incorporate factors related to the anticipated holding periods of assets and liabilities, their market liquidity risk characteristics, and any other relevant factors, including the benefits from having access to relatively stable sources of funding, such as some types of retail deposits.
        The quantification and attribution of these risks must be explicit and transparent at the line management level and must include consideration of how liquidity would be affected under stressed conditions.
        The analytical framework must be reviewed as appropriate to reflect changing business and financial market conditions and so maintain the appropriate alignment of incentives.
      20. t.IBs must assess its aggregate foreign currency liquidity needs and determine acceptable currency mismatches. IBs must undertake a separate analysis of its strategy for each currency in which it has significant activity, considering potential constraints in times of stress. The size of foreign currency mismatches must take into account: (a) the IB’s ability to raise funds in foreign currency markets; (b) the likely extent of foreign currency back-up Shari’ah compliant facilities available in its domestic market; (c) the ability to transfer a liquidity surplus from one currency to another, and across jurisdictions and legal entities; and (d) the likely convertibility of currencies in which the bank is active.
        IBs must take account of the risks of sudden changes in foreign exchange rates or market liquidity, or both, which could sharply widen liquidity mismatches and alter the effectiveness of foreign exchange hedges and hedging strategies.
         

    • 5.7 Control and Mitigation of Liquidity Risk

      1. a.IBs must ensure that it has a well-diversified funding base, which must be commensurate with the nature and size of its business, products offered and regulatory market environment. It must maintain strong relationships with various fund providers – retail, corporate or interbank – to ensure proper diversification of its funding base. It must also be able to identify major factors that influence the decision-making process of various fund providers and take measures to control and mitigate those factors, as well as to maintain relationships with its core investment funds and deposit base. The diversification of funding sources must span a range of maturities, including the short, medium and longer term, so as to provide a suitable match with maturities in its assets portfolio.
      2. b.As a part of its diversification strategy, an IB must manage and limit its funding concentrations. IB must limit funding concentrations by name–type, product, geographical location, sector, currency and nature of the provider.
      3. c.IBs that rely on the funding from wholesale investors as a major funding source must assess the likelihood of being able to continue to rely on keeping funds with such investors when under duress and must incorporate in its analysis that funding from wholesale investors might dry up in stressed conditions.
      4. d.IBs may use securitisation of financing and investment assets for managing liquidity, freeing up assets from the balance sheet and raising new funds, in addition to reducing their risk exposures.
      5. e.IBs must also take into consideration the features and risks of various sources of funds and mechanisms e.g. retail and corporate fund providers on the basis of current accounts, investment accounts, other type of accounts, and the Islamic interbank market. being used.
      6. f.Preserving market access is an important element of achieving diversification in the funding base of IB. Access to various funding markets ensures that the IB is able to raise new funds and sell its Shari’ah-compliant assets and Sukuk with ease and without a major price distortion. IB must also be able to spot alternative funding sources in order to meet any situation of market duress and these must form part of its CFP. Possible sources of such funding in the IB may be an expansion of its deposits and investment accounts, securitisation, the sale of unencumbered Shari`ah-compliant assets, the drawing down of committed lines of financing, accessing the local Islamic interbank market, secured financing through Shari’ah-compliant alternative structures, etc.
         

    • 5.8 Consolidated Management of Liquidity Risk

      1. a.In the case of an IB that is part of a group which has a centralised structure for managing liquidity risk, the Board and Senior Management at the group/parent level must prepare a strategy, policies and procedures for the Islamic operations taking into account the position of such operations within the overall group/parent, with due consideration to mutual Shari’ah independencies and constraints in transfers of liquidity on a Shari’ah-compliant basis between the group entities.
      2. b.A major consideration in the transfer of liquidity from an Islamic entity to the conventional group/head office, or vice versa, is the issue of segregation of funds, constraints on any such transfer, and the Shari’ah-compliant structures or mechanisms that can be used to facilitate the placement of funds.
         

    • 5.9 Maintaining a High-Quality Liquidity Buffer

      1. a.IBs must maintain a liquidity buffer as the first line of defense in the event of a liquidity disruption. A liquidity buffer consists of cash and other highly liquid, unencumbered, Shari’ah-compliant assets and is an important tool in disruptive market conditions when an IB may need to generate liquidity in a short span of time and normal funding sources become dry or are unable to provide liquidity. The availability of this excess liquidity precludes the need for an IB to take extraordinary measures during initial periods of stress.
      2. b.IBs must calibrate the magnitude of its liquidity buffer on the basis of its funding gap and stress testing exercise over specific time horizons. The calibration of a liquidity buffer is highly dependent on assumptions used for defining the stress conditions. These assumptions incorporate the factors such as net and cumulative funding requirements in various time buckets, as well as encompassing both contractual and non-contractual cash flows. Assumptions must also include factors such as the length and severity of stress, the withdrawal of funding by investment accounts and depositors, and the non-availability of funding on an unsecured basis (including interbank Mudarabah, and Wakalah) as well as on a secured basis (using Shari’ah-compliant alternatives structure to a repurchase agreement) from modestly liquid assets.
      3. c.The IB liquidity buffer must comprise cash and highly liquid assets which can be sold or used as collateral for a Shari’ah-compliant alternative to a repurchase agreement in disruptive market conditions.

        In addition to the highly liquid instruments, other instruments which may need a relatively longer time in liquidation may be considered, provided the IB can demonstrate the ability to generate the liquidity from such instruments in an agreed timeframe. The core component of this buffer must be eligible as collateral for generating liquidity from the Central Bank on a Shari’ah-compliant basis.

      4. d.The IB can also include statutory reserves with the Central Bank in its calculation of a liquidity buffer provided it can demonstrate that such reserves can be withdrawn in case of need without any regulatory repercussions. The criteria for specifying an instrument’s eligibility as a liquidity buffer include its issuer, size, maturity, depth of the market, currency, tradability from a Shari’ah perspective, and the range of investors holding such an instrument.
      5. e.IBs must ensure that its liquidity buffer is reasonably diversified, and that there are no constraints – whether legal, regulatory or operational – on the utilisation of these assets. The IB must also consider maintaining buffers of highly liquid assets in other major currencies, especially in cases where the local currency is non-convertible.
      6. f.An IB must also test and be active in each market in which it keeps Shari’ah compliant assets as liquidity buffers. This will provide an assurance to the IB about the liquidity of such instruments in various market conditions and will provide an opportunity to test its assumptions.
         

    • 5.10 Preparing a Contingency Funding Plan (CFP)

      1. a.IBs, regardless of their nature and complexity, must have a CFP that delineates the strategy, action plan and procedures for dealing with liquidity stress events, including making up cash flow in adverse circumstances. Such a plan must be prepared with input from all relevant functions of the IB, while carefully incorporating the results from stress tests, including scenario analyses and considering any limitations to sourcing funding in the future.
      2. b.The CFP must establish a clear designation of roles and responsibilities and backup of key functions, with a suitable internal and external communication plan addressing various stages of stress events. The plan must include regular monitoring of related triggers, with appropriate escalation procedures.
      3. c.Key objectives of a CFP are to reduce the effects of liquidity shocks, maintain going-concern status, and send market signals that the IB is in reasonable health.
      4. d.The main components of a CFP include:
        1. i.definition of the triggering events that will activate the CFP;
        2. ii.governance of the CFP during the various stages of stress events, including describing the roles and responsibilities of various functions and committees;
        3. iii.escalation procedures explaining when to consider, and how to take, additional measures for generating funds;
        4. iv.internal and external communication plans, including major counterparties, customers, investment account holders, auditors, media and the Central Bank; and
        5. v.the frequency and parameters used as a basis for revising the CFP.
      5. e.CFPs must have the following characteristics:
        1. i.Be commensurate with a IB’s complexity, risk profile, scope of operations and role in the financial systems in which the IB operates.
        2. ii.Include a clear description of a diversified set of contingency measures for preserving liquidity and making up cash flow shortfalls in various adverse situations.
        3. iii.Articulate available potential contingency funding sources and the amount of funds a bank estimates can be derived from these sources; clear escalation/prioritisation procedures detailing when and how each of the actions can and must be activated; and the lead time needed to tap additional funds from each of the contingency sources.
        4. iv.The CFP's design, plans and procedures must be closely integrated with the IB’s ongoing analysis of liquidity risk and with the results of the scenarios and assumptions used in stress tests.
        5. v.It must prepare the IB to manage a range of scenarios of severe liquidity stress that include both IB-specific and more generalised market-wide stress, as well as the potential interaction between them.
        6. vi.It must include a diversified menu of options to allow management to have an overview of the potentially available contingency measures. Banks must also examine the time periods for which measures can be carried out under various assumptions and stresses.
      6. f.IB’s CFP must be closely integrated with the overall strategy, policies and procedures for managing liquidity risk and must be proportionate with the IB’s size, nature of products, risk profile and level of tolerance. It must also address constraints on obtaining Shari’ah compliant funding.
      7. g.During the process of preparation of the CFP, an IB must take input from all relevant functions and bodies, and most importantly from the senior management, treasury, and risk management and finance departments. It must be then formally approved by the Board of the IB.
      8. h.IBs must also define the triggering events that will activate the various stages of the CFP. Such events may include events related to the IB, such as a downgrade in its credit rating or that of Sukuk that it has originated or for which it is an obligor; problems in specific products or lines of business (e.g. issues affecting an important market segment resulting in a reduction of cash flows to the IB from losses of customers and collectability problems); and/or the default or a rating downgrade of Sukuk it is holding, etc.
      9. i.There might be some external events that can cause the need for activation of CFP, such as a lower rating or defaults in its holding of Sukuk or other Shari’ah-compliant securities, deterioration of overall market conditions, negative publicity about its Shari’ah compliance, or changes in legal, accounting and tax regulations that might impact negatively on the IB’s liquidity position. IB is expected to perform regular monitoring of related triggers that will activate the CFP with related reporting to the senior management and relevant committees such as ALCO.
      10. j.IBs must clearly designate the roles and responsibilities of the various personnel involved in the management of the CFP during each stage of the liquidity crisis. An IB must define the classification of these stages and may consider delimiting various stages, such as:
        1. i.recognition of various triggering events where withdrawals do not follow predictable patterns;
        2. ii.a liquidity crunch where unsecured funding might be partially inaccessible and there is a need to liquidate assets or investments in an orderly manner; and
        3. iii.a condition of severe liquidity shock where unsecured funding is not available and securing funding is difficult to obtain.
      11. k.During the course of each defined stage, the IB must lay down the roles and responsibilities of the relevant board and senior management committees, as well as other staff, in order to prevent any confusion and misconception about their roles. IB can also consider the establishment of a crisis management team with clearly assigned leadership roles to increase internal coordination and decision-making during a liquidity disruption.
      12. l.The IB CFP must illustrate the decision-making process to be adopted at different stages of the liquidity crisis. The process must outline the nature and timing of action to be taken by the personnel responsible for managing liquidity disruptions with respect to their assigned roles. It must also elaborate the parameters for escalating any issue to higher senior management. The procedures must explain the nature and extent of internal and external communication.
      13. m.The communication plan of the IB, as defined in the CFP, must ensure clear, timely and regular internal communication to warrant timely decision-making and avoid any misconception or confusion about the appropriate steps to be taken during the crisis and roles of the various personnel.
      14. n.Senior management must review and update the CFP at least every year for the Board’s approval, or more often as business or market circumstances change. The review must take place in order to assess its effectiveness and to ensure that it remains relevant and up to date in the changing market conditions. An IB may consider assessing the efficacy of CFP during the simulation of stress conditions, if conducted and make appropriate changes to reflect the applicability of the CFP if needed.
      15. o.IBs must also conduct regular contingency tests to ensure that key exposures are taken into account, contingency procedures are well understood, and relevant expectations from each function are clear during times of crisis. The testing procedure must also assess the reliability of key contacts, the effectiveness of legal and operational documentation, the availability of credit lines, and the marketability of its Shari`ah-compliant asset portfolio by selling or through any collateralised mechanism. Key aspects of these tests include:
        1. -ensuring that roles and responsibilities are appropriate and understood,
        2. -confirming that contact information is up to date,
        3. -proving the transferability of cash and collateral,
        4. -ensuring that the necessary legal and operational documentation is in place to execute the plan at short notice,
        5. -proving ability to sell or purchase certain assets or periodically draw down credit lines.
      16. p.The CFP must be consistent with the IB’s business continuity plans and must be operational under situations where business continuity arrangements have been invoked.
         

    • 5.11 Managing Shari’ah-Compliant Collateral

      1. a.IBs must be able to identify its needs for Shari’ah-compliant collateral over different time horizons, and must address the Shari’ah, legal and operational constraints on the use of such collateral. The IB must actively manage its collateral positions while differentiating between encumbered and unencumbered assets, and its information system must be able to identify available unencumbered collateral by type, currency and location, in both normal and stressed times.
      2. b.IBs must have a strategy, policies and procedures in place in order to ascertain its collateral needs over various time horizons in both normal and stressed times. The IB must also determine the Shari’ah, legal, regulatory and operational constraints on utilisation and transfer of collateral over different jurisdictions and currencies, and according to the nature of assets. The IB must also estimate the level of collateral according to its liquidity buffer requirements and in consideration of the various stages of liquidity crisis stated in its CFP. The IB must also explore the opportunity to expand the range of collateral it is holding, which can be diversified in terms of currency, jurisdiction, type and tenor.
      3. c.An IB must actively manage its collateral positions while differentiating between encumbered and unencumbered assets. The IB must have a robust management information system that can meet the requirements and challenges of liquidity risk management and keep track of expected cash flows in light of contractual and behavioral profiles of assets, liabilities and off-balance sheet items.
         

    • 5.12 Collaboration Between IBs

      1. a.IBs, especially within the same jurisdiction, should closely cooperate among themselves in order to develop Shari’ah-compliant arrangements, solutions and trading mechanisms for liquidity management purposes.
      2. b.Such collaboration shall provide a robust platform and harmonised agreements for active trading amongst the IBs, with availability of market makers in various trading instruments and mechanisms.
         

    • 5.13 Meeting Payment and Settlement System Obligations

      1. a.Irrespective of whether an IB uses a net or a gross payment and settlement system, it must be able to manage short-term (overnight and intraday) liquidity in order to meet, on a timely basis, its payment and settlement obligations in all circumstances.
      2. b.In view of the interdependencies and interconnectedness between payment and settlement systems, IBs must ensure that its critical payments are always made on a timely basis in order to avoid any potential systemic disruptions, which could prevent the smooth functioning of other payment systems and money markets.
      3. c.IBs must monitor important liquidity flows and must directly contact the counterparties in the case of any late payments. IB must also assign clear roles and responsibilities with respect to the intraday management of liquidity. Looking at the time-critical nature of intraday liquidity management, IB must be able to formalise its decision-making and follow-up processes so that settlements can be monitored on a continuous basis with proper internal controls and allocation of responsibilities. Its management information system must be facilitative enough to provide the senior management and other relevant personnel with information on the IB’s liquidity and collateral positions, with flexibility to provide more detailed information when needed, especially during stressed market conditions.

        IBs must implement back-up measures in order to reduce any operational problems, such as problems with trading and settlement systems, information system networks and unauthorised access to the systems, etc. The IB must also take account of intraday considerations in its stress testing and scenario analysis exercise, the results of which must be incorporated into its CFP. IB must include the possibility of any unforeseen interruption in its intraday liquidity flows as a part of its liquidity risk planning.
         

    • 5.14 Foreign Exchange Liquidity Risk

      1. a.IB must have a measurement, monitoring and control mechanism for liquidity positions in each currency with a significant exposure. IB must assess, monitor and, where appropriate, limit the size of its cash-flow mismatches over particular time horizons for foreign currencies in aggregate and for each significant individual currency in which it operates, especially with respect to its domestic currency (or, where different, its functional currency).
      2. b.The IB must employ appropriate stress tests and make use of Shari’ah-compliant hedging strategies for limit setting and controlling currency risk. The IB must especially limit its exposures in currencies that are not highly liquid or have low convertibility.
      3. c.As a part of the overall stress testing exercise of the IB, foreign exchange liquidity must also be analysed under normal and stressed market conditions. The IB must adopt hedging techniques, including Shari`ah-compliant derivatives, if any (the swap market, in particular), remains a key feature of managing relevant foreign exchange exposures.
      4. d.Where an IB provides financing facilities in foreign currencies, it can face a number of risks that must be considered as a part of its overall liquidity risk management strategy and policies. IB must consider the impact of changes in foreign currency exchange rates with respect to the domestic currency and the likely convertibility of these currencies in the event of need. In the case of an unexpected currency devaluation, local customers will be unable or will find it difficult to pay back their foreign currency financing, resulting in cash-flow problems for the IB providing such financing. As a part of its foreign currency liquidity strategy, IB must evaluate the profile of its customers in terms of the nature of its business and the sources of earnings which can impact its ability to settle the foreign currency financing.
      5. e.IB must apply suitable limits on mismatches and positions in various foreign currencies on the basis of appropriate stress tests and scenario analysis. These limits must be reviewed on a regular basis. IB must also evaluate the possibility of loss of access to the foreign exchange markets, as well as the inability or difficulty in swapping currencies in the case of market disruption.
      6. f.Foreign exchange settlement risk arises when an IB finds itself in unexpected positions in currencies as the result of a counterparty’s failure to settle its payments on time. In the correspondent settlement of foreign exchange, the full amount of settlement is at risk until the counterparty fulfils its foreign currency obligations. IBs must establish effective control measures and communications channels in order to mitigate any such settlement risk.
         

    • 5.15 Reporting and Disclosure of Liquidity Risk

      1. a.An IB must have a fully integrated information system, commensurate with its nature, size and complexity of operations, that provides clear, timely and accurate liquidity risk reports to its relevant functional units and senior management. The information system must, at suitable intervals, present to senior management and the Board a clear understanding of the IB’s liquidity risk exposures and vulnerabilities, its compliance with established policies and limits, as well as the appropriateness of management strategies with respect to approved risk tolerance.
      2. b.IBs must have a reliable management information system designed to provide the Board, senior management and other appropriate personnel with timely and forward-looking information on the liquidity position of the IB. The management information system must have the ability to calculate liquidity positions in all of the currencies in which the bank conducts business – both on a subsidiary/branch basis in all jurisdictions in which the bank is active and on an aggregate group basis. It must capture all sources of liquidity risk, including contingent risks and the related triggers and those arising from new activities, and have the ability to deliver more granular and time sensitive information during stress events.
      3. c.To effectively manage and monitor its net funding requirements, IBs must have the ability to calculate liquidity positions on an intraday basis, on a day-to-day basis for the shorter time horizons, and over a series of more distant time periods thereafter. The management information system must be used in day-to-day liquidity risk management to monitor compliance with the bank’s established policies, procedures and limits.
      4. d.The IB must make appropriate and regular disclosures of qualitative and quantitative information about its liquidity position and liquidity risk management practices through suitable channels.
      5. e.Senior management must define the types, contents, scope and frequencies of reporting to different levels of management and the board, including various committees such as ALCO and the risk management committee.
      6. f.Liquidity risk reports must provide aggregate information with adequate supporting granularity to enable the recipients to assess the liquidity risk position of the IB in changing market conditions. The reports must pick up any “early warning signals” and provide enough information to the recipients for them to make informed decisions and appropriate changes in policies, procedures and associated thresholds. The reports must also provide information on compliance with the IB’s established policies and procedures, along with details of any breaches and exceptions. The reporting must enable the management to evaluate trends in the aggregate liquidity risk exposure of the IB, as well as its components, in order to provide a basis for timely decision-making and corrective actions.
      7. g.IB’s liquidity risk disclosures must include:
        1. i.summary of the liquidity risk management framework that addresses risk exposure for each category of funding (current accounts, unrestricted and restricted IA), as well as on an aggregate basis;
        2. ii.general information on policies to manage and mitigate liquidity risk, taking into account the ease of access to Shari`ah-compliant funds and the diversity of funding sources;
        3. iii.indicators of exposure to liquidity risk, such as the ratio of short-term assets to short-term liabilities and investment accounts, liquid asset ratios or funding volatility;
        4. iv.maturity analysis of financing and various categories of funding (current account, unrestricted and restricted investment account) by different maturity buckets;
        5. v.policy on maintaining liquidity buffers;
        6. vi.the frequency and type of internal liquidity reporting;
        7. vii.an explanation of the utilisation of stress testing in a liquidity risk management framework;
        8. viii.a summary of the features and testing plans of the CFP; and
        9. ix.supervisory restrictions on the transfer of liquidity among group entities, if any.