An Introduction to Islamic Finance: Theory and Practice

310 AN INTRODUCTION TO ISLAMIC FINANCE

reserves maintained by IFIs to minimize commercial displaced, withdrawal and
systemic risks. In markets where IFIs are maintaining PER and IIR, the supervi-
sory authorities are given discretion to adjust the denominator of the CAR for-
mula according to their judgment of the systemic risk and prevailing practices.
This percentage is applied to assets fi nanced by both unrestricted and
restricted IAHs. Further adjustment is made for PER and IRR reserves in such a
manner that a certain fraction of the risk - weighted assets funded by the reserves
is deducted from the denominator. The rationale given for this adjustment is
that these reserves have the effect of reducing the displaced commercial risk.
As Basel II takes into account the capital requirements for operational
risk, the IFSB’s exposure draft also deals with the issue in detail. Diffi culties in
quantifying the exposures from operational risk make determining how much
capital should be allocated for such risks complex. The IFSB recommends that
this may be based on either the Basic Indicator Approach or the Standardized
Approach.^3 It is further recommended that, given the different structure of
their lines of business, at the present stage IFIs may use the Basic Indicator
Approach. An example of how CAR may be calculated is shown in Table 14.3.

TABLE 14.3 IFI CAR computation: An example

Liabilities:
Demand Deposits $200M
Unrestricted Investment Account Deposits $500M
Restricted Investment Account Deposits $250M
PER and IRR $50M

Shareholders’ Capital $20M

Assets:
Trade Financing (Murabahah) $550M
Salam/Ijarah/Istisna’ $250M
Mudarabah and Musharakah Investments $220M

Total Risk-weighted Assets for credit risk $250M
Risk-adjusted Assets Financed by Investment Account Holders $100M
Risk-adjusted Assets Financed by PER and IRR $10M
Supervisory Authority’s discretion (α) 30%
Adjustment for Market and Operational Risk (12.5 × $5M) $62.5M

CAR According to Standard Formula:

$20

($250M + 62.5M ) – ($100M + $10M)

= 9.88%

CAR According to Supervisory Discretion Formula:

$20

($250M + 62.5M) – (0.7 × $100M – 0.3 × $10M)

= 8.35%