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Regulatory measures to mitigate the impact of COVID-19 for Institutions Offering Islamic Financial Services (IIFS)

Date posted: 8 July 2020

The COVID-19 pandemic and various unprecedented policy responses taken by the Governments to contain the spread of the virus have had an increasingly significant impact on the global economy and financial markets. The Islamic Financial Services Board (IFSB) noted the suites of extraordinary measures including the range of regulatory and supervisory responses that have been rolled out by its member jurisdictions to preserve resilience of the financial system and the continued provision of financial services to the real economy. These include payment moratorium1 and Shariah-compliant government guarantees on bank exposures to certain segments of the recipients of Shariah-compliant financing.

The current development necessitates the IFSB to issue public statements and provide technical guidance related to the extraordinary measures when calculating capital requirements of IIFS, in line with treatments prescribed by the International Accounting Standards Board (IASB)2 , the Basel Committee on Banking Supervision (BCBS)3 and the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI)4, on 27 March 2020, 3 April 2020, and 21 May 2020, respectively, and to ensure that such treatment are not in conflict with Shariah rules and principles.

Treatment of payment moratorium (on the payment of debt without any increase in due payment amount) and Sharīʻah-compliant government guarantees in determining capital requirements

Payment moratorium period relating 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 IIFS. Another criterion to be considered by IIFS 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 IIFS, RSAs should prescribed appropriate risk weight to reflect the Shariah-compliant governments guarantees and other risk sharing mitigation measures introduced by authorities in dealing with the Covid-19 pandemic. 

Expected Credit Loss Accounting

Payment moratorium and Shariah compliant government guarantees on financing exposures also have impacts on credit risk as well as the calculation of the expected credit loss (ECL) as provisioned in the IFRS 9 and FAS-305. In view of this, the IFSB recommends the following approach to guide RSAs in spelling out regulatory guide to IIFS in respect of impairment allowance:

  • Given that IFRS 9 is principle-based, sound judgement in its application is of paramount importance especially at this time of high level of uncertainty. 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. The payment moratorium, for instance, may not automatically result in IIFS exposures moving from a 12-month ECL to a lifetime ECL measurement, as it does not necessarily imply a significant increase of credit risk. However, the changes in macroeconomic factors may be an indicator of objective evidence of the increase in credit risk6.  Therefore, IIFS are expected to review the status of the exposures and the ability of the customer to resume payment after the moratorium period.
  • The IFSB takes cognisance of the BCBS April 2020 guidance related to the transitional arrangements for the implementation of the ECL model in light of the ongoing crisis, and adopts similar measures as follows: 
    • Jurisdictions that follow the transitional arrangements for the ECL accounting as prescribed by the BCBS may consider the following the amendments to the existing transitional arrangements for the regulatory capital treatments of ECLs:
      1. Jurisdictions may apply the existing transitional arrangements, even if they were not initially implemented when IIFS first adopted the ECL model. They may also choose to apply the alternative transition set out in point (iv) below.
      2. RSAs may permit IIFS 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).  
      3. In addition to the two existing approaches to calculate the transitional adjustment amount (the static and dynamic approach), 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. 
      4. For transitional arrangements covering the 2-year period comprising the years 2020 and 2021, jurisdictions may choose to allow IIFS to add-back up to 100% of the transitional adjustment amount to CET1. The “add-back” amount must then be phased-out on a straight-line basis over the subsequent 3 years. 
  • Disclosure requirements related to the transitional arrangements remain unaffected where IIFS would need to disclose whether a transitional arrangement is applied and the impact on its regulatory capital and leverage ratios compared to the “fully loaded” capital and leverage ratios, had the transitional arrangements not been applied. 

Profit-sharing Investment Accounts  

The IFSB standards describe several profit-smoothing techniques for IIFS that provide profit-sharing investment accounts. These techniques are employed to varying degrees by IIFS across different countries as this is determined by each jurisdiction’s Islamic banking laws, regulations and policies.  

IIFS that offer unrestricted investment accounts and maintain a profit equalisation reserve (PER) and/or an investment risk reserve (IRR) may utilise or drawdown these reserves for profit smoothing (through PER) or absorption of losses (through IRR) including in these trying economic conditions due to the pandemic. Other IIFS, which maintain neither reserve may continue to adhere to the terms of its contracts with investment account holders (IAH) in relation to the bearing of losses. 

Maintaining the above arrangements during times of stress and uncertainty would also require RSAs to stress the need for transparency as well as appropriate and timely disclosures by IIFS to their investors. In this regard, the 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, utilisation of PER and IRR, and transfers to PSIA profits from shareholders’ funds (if any) on the basis of unconditional support. Such disclosures must be aimed at enabling IAH to make informed decisions without creating any procyclicality effects. Investors may also need assurance that their investments remain Shari’ah compliant. Disclosure of the impact of the current crisis may also include measures taken by central banks, governments, or regulatory and other bodies which positively supported the performance of the IIFS or its investments, and the use of third-party undertakings for PSIA. 

It is critical that these disclosures are made in a timely manner and using simplified language to enable retail and other investors to monitor the performance of IIFS and their own investments, thereby contributing to market discipline. 

The IFSB will continue to assess and address the implications of COVID-19 on these and other areas in Islamic banking and make further public statements where necessary.

Payment moratorium in this statement implies that the recipients of financing will be given a grace period for the payment of their due obligations. However, this should not result in any increase on the due payment obligation.


https://www.bis.org/bcbs/publ/d498.pdf: Measures to reflect the impact of Covid-19


See details on the statements issued by AAOIFI on expected credit losses and impairment of assets as provisioned by FAS-30 - http://aaoifi.com/accounting-implications-of-the-impact-of-covid-19-pandemic/?lang=en


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