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Presentation Outline
6 Cs of Credit
Definition of Credit
Credit is the provision of resources by one party to another party where the second party does not reimburse the first party immediately (thereby generating a debt), but instead arranges either to repay or return those resources (or other materials of equal value) at a later date. The resources provided may be financial (e.g. granting a loan), or they may consist of goods or services (e.g. consumer credit)....Wikipedia
Type of Credit
Conventional
Interest based e.g. Housing Loan, Hire Purchase, Bond Non interest based e.g. Venture Capital, Bank Guarantee
Islamic
Debt based
6 Cs of Credit
1.
2. 3. 4. 5.
Assessment Criteria
Capital
Character Capacity Condition Collateral
6.
Common Sense
Credit risk is simply defined as the potential that a borrower or counterparty will fail to meet its obligation in accordance with agreed terms.*
It is the risk of failure of the counterparty to honor their commitment (moral hazard), and is also referred as default risk.
*Basel Committee of Banking Supervision, Principles for the Management of the Credit Risk, Bank for International settlement, Basel, Switzerland (1999)
Parallel Istisna
Ijara
Mudharaba Musharaka
- Mudarib fail to remit profit and capital - Incompetent Mudarib - Incompetent business partner (IFI & Partner) - Failure to inject capital by any of the partners
Run
Insolvency
Counterparties Islamic Financial Contracts Guaranties and Collaterals (to cover potential losses)
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Based on quantitative statistical models Data used for modeling the credit risks
Data referring to the past and current behavior of the counterparty Data that defines the losses of the associated risks
Hybrid models
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Depends on the calculation of Probability of Default - PD (likelihood of counterparty defaulting) Loss Given Default LGD (weighting of loss at default) and Exposure at Default EAD (estimation of institutions exposure in the event of or at the time of default)
Correlation between a portfolios assets are analysed Estimation of Economic Capital to be held as buffer against the Unexpected Credit Losses
Lack of loss data major hindrance for young Islamic Banking industry
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Banks should not hold significant equity positions in companies they finance. Reason : risk a bank takes increases when owner- ship and the provision of debt funding are in the same hands As a result of this belief, banks that hold equity positions in the companies they finance (e.g., as in Mudaraba and Musharaka transactions) are heavily penalized. Issue for Islamic Banks due to Mudaraba and Musharaka transactions due to PLS nature of contracts Banks with transactions with PLS nature have RWA of 400% In Malaysia, this condition modified to RWA of 250% Hence Islamic Banks avoid these transactions due to high capital requirement and capital costs
*Islamic Finance: Risk Management Challenges and the Impact of Basel II - Dr.Natalie Schoon
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Thank you
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