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Article (11) Credit Risk

CBUAE/BSD N 1198/2021 Effective from 25/2/2021
  1. 11.1IBs must have in place:
    • -an appropriate credit strategy, including pricing and tolerance for undertaking credit risks exposures;
    • -a risk management structure with effective oversight of credit risk management; credit policies and operational procedures including credit criteria and credit review processes, acceptable forms of risk mitigation, and limit setting;
    • -an appropriate measurement and careful analysis of exposures, including market and liquidity-sensitive exposures; and
    • -a system (a) to monitor the condition of ongoing individual credits to ensure the financings are made in accordance with the IBs’ policies and procedures, (b) to manage credit challenges according to an established remedial process; and (c) to ensure adequate provisions are allocated.
  2. 11.2IBs must have in place an appropriate framework for credit risk management and reporting in respect to all assets. This includes credit risk related to different stages of the Shari’ah compliant products and investments. IBs must apply the credit risk principles to credit risks associated with securitization and investment activities.
  3. 11.3The risk assessment and measurement processes undertaken by IBs must also be applicable to profit sharing assets (Mudaraba and Musharaka) which are classified under equity investments. Rigorous risk evaluation (including due diligence) and controls of these investments are necessary in view of their exposure to capital impairment. This must not contradict the risk sharing nature in these instruments as prescribed by Islamic Shari’ah.
  4. 11.4IBs must have in place a strategy for financing, using various instruments in compliance with Shari’ah, whereby the strategy recognizes the potential credit exposures that may arise at different stages of the various financing agreements.
  5. 11.5IBs must manage and account for the credit risk arising from Shari’ah compliant instruments where:
    • -no Shari’ah compliant compensation can be imposed, and/or
    • -the profit cannot be increased/continued.
  6. 11.6IBs must have a policy for carrying out a due diligence review in respect of counterparties prior to deciding on the choice of an appropriate Shari’ah compliant financing instrument.
    This has to be carried in particular, for transactions involving:
    - New ventures with multiple financing modes: IBs should carry out due diligence processes on customers using multiple financing modes to meet specific financial objectives designed to address Shari’ah, legal or tax issues of customers.
    - Creditworthiness that may be influenced by external factors: Where significant investment risks are present in participatory instruments, especially in the case of Mudarabah financings, additional counterparty reviews and evaluations will focus on the business purpose, operational capability, enforcement and economic substance of the proposed project including the assessment of realistic forecasts of estimated future cash flows. IBs should put in place risk mitigating structures in place to the extent possible.
  7. 11.7IBs must have in place Shari’ah compliant credit risk mitigating techniques appropriate for each Islamic financing instrument. IBs must be aware of the commencement of exposure to credit risk inherent in different financing instruments such as the non-binding nature of certain contracts. Risk management techniques should not change the nature or the Shari’ah aspects of the contract in order to mitigate the risk.
  8. 11.8IBs should clearly define their credit risk-mitigating techniques including, but not limited to, having in place:
    • -a methodology for setting mark-up rates according to the risk rating of the counterparties, where expected risks should be taken into account in the pricing decisions;
    • -permissible and enforceable collateral and guarantees;
    • -stipulating the counter party’s commitment to donate in case of default in the legal documentations in accordance with the applicable Shari’ah resolutions and standards;
    • -clear documentation as to whether or not purchase orders are cancellable; and
    • -clear procedures for taking account of governing laws for contracts relating to financing transactions.
  9. 11.9In a financing involving several related agreements, IBs must be aware of the binding obligations arising in connection with credit risks associated with the underlying assets for each agreement. IBs must ensure that all components of a financial structure comply with the Shari’ah parameters applicable to combination of contracts.
  10. 11.10IBs must establish limits on the degree of reliance and the enforceability of collateral and guarantees subject to the provisions set-out within the relevant rules of Islamic Shari’ah.
  11. 11.11IBs must have appropriate credit management systems and administrative procedures in place to undertake early remedial action in the case of financial distress of a counterparty or, in particular, for managing bad credits, potential and defaulting counterparties. This system should be reviewed on a regular basis. Remedial actions will include both administrative and financial measures.
    Administrative measures may inter alia include:
    • -negotiating and following-up pro-actively with the counterparty through maintaining frequent contact with the counterparty;
    • -setting an allowable timeframe for payment or to offer rescheduling (without an increase in the amount of the debt in debt based instruments) or Shari’ah compliant restructuring arrangements;
    • -using a debt-collection agency;
    • -resorting to legal action, including the attachment of any credit balance belonging to defaulters according to the agreement between them; and
    • -making a claim under Shari’ah-compliant insurance as applicable.

    Financial measures may include, among others:

    • -invoking commitment to donate clauses, where applicable, in accordance with the relevant Shari’ah parameters,; and
    • -establishing the enforceability of collateral or third party guarantees.
  12. 11.12IBs must set appropriate measures for early settlements.
  13. 11.13IBs must have policies to define adequately the action to be taken by the IB when a customer cancels a non-binding purchase order.
  14. 11.14IBs should assess and establish appropriate policies and procedures pertaining to the risks associated with their own exposures in parallel transactions.
  15. 11.15IBs must ensure, whenever possible or applicable, that there is sufficient Shari’ah-compliant insurance coverage of the value of the assets.
  16. 11.16IBs must have in place an appropriate policy for determining and allocating provisions for (a) non-performing debt categories, including counterparty exposures; and (b) estimated impairment in value of assets.