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IFSB Unveils Technical Guidance For Stress Testing

The Islamic Financial Services Board (IFSB) has issued exposure draft of technical Note-2 on stress testing for institutions offering Islamic Financial Services (IFS) [Banking Segment] for public consultation.

According to a statement by the IFSB, the aim of ED TN-2 is to provide regulatory and supervisory authorities (RSAs) and market players of the Islamic banking industry with technical guidance to develop, conduct and assess stress tests. ED TN-2 follows on from, and complements, the earlier IFSB- 13, Guiding Principles on Stress Testing for Institutions offering Islamic Financial Services.

ED TN-2 provides stress-testing scenarios that address multiple types of risks and their interrelated effects on the overall financial position and performance of the portfolio, the institution itself or the overall financial system.

These risks include, but are not limited to, credit risk within financing portfolios, market risk on assets held, foreign exchange risk, and liquidity risk. The ED TN-2 incorporates risk specificities of Shari’ah-compliant contracts’ when conducting stress tests on an IIFS.

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This involves evaluating the various risk exposures experienced by an IIFS, which are segregated by the contractual relationships of the balance sheet components.

A key feature of ED TN-2 is that it is accompanied by four basic stress test templates: one each for conducting credit, market and liquidity risk assessments as well as a scenario analysis template that combines credit and market risk stress tests.

The proposed basic stress test templates in ED TN-2 provide the flexibility of having stress test results analysed and assessed across three levels: at a portfolio level, at an institutional level and also at the aggregate system-wide level.

The scope of this TN is limited only to the Islamic banking sector, and is aimed at both the institutional level (i.e. used by institutions to assess institutions’ risk tolerance and capital level) and system-wide stress tests (i.e. used by RSAs as a supervisory tool for financial stability analysis stress testing).

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RSAs may extend the application of this TN to Islamic “window” operations that are self-contained or modify it for application to other types of IIFS that fall within their jurisdictions.

In line with the IFSB due process on the development of Standards and Guiding Principles, the IFSB will be organising a Public Hearing for ED TN-2 on 25 April 2016 at Sasana Kijang, Kuala Lumpur, Malaysia.

This platform aims to provide industry stakeholders an opportunity to raise issues facilitating greater understanding of the Exposure Draft, as well as to solicit feedback on its contents, prior to its final submission to the IFSB Council in December 2016. Participation of the Public Hearing is free and open to all.