Abstract

7.1 This chapter brings together the concepts and definitions set out so far, to explain how core financial soundness indicators (FSIs) for deposit takers (DTs) are to be calculated.1 The accounting principles and calculation methods for core FSIs presented in this chapter also apply to the additional FSIs for DTs. The availability of data reported to supervisory agencies will determine the scope of the data that can be compiled and disseminated.

I. Introduction

7.1 This chapter brings together the concepts and definitions set out so far, to explain how core financial soundness indicators (FSIs) for deposit takers (DTs) are to be calculated.1 The accounting principles and calculation methods for core FSIs presented in this chapter also apply to the additional FSIs for DTs. The availability of data reported to supervisory agencies will determine the scope of the data that can be compiled and disseminated.

7.2 For most of the FSIs, the Guide recommends that the data series be drawn from sectoral financial statements. For each reporting DT group, data need to be compiled on a consolidated basis as described in Chapter 6.2

Accounting Principles

7.3 The accounting principles are discussed in Chapter 4. Except where otherwise noted, the following principles should be applied when compiling the underlying series used to calculate FSIs:

  • Transactions and positions should be recorded on an accrual basis, and only existing actual assets and liabilities should be recognized (paragraphs 4.10–4.13).

  • Valuation methods should provide the most realistic assessment at any moment in time of the value of an instrument or item. Market value is the preferred basis of valuation of transactions, as well as for positions in traded securities. For positions in instruments not designated for trading or available for sale,3 the Guide defers to International Financial Reporting Standards (IFRSs).

  • Provisions for loan losses comprise specific provisions created to cover identified non-performing loans.4

  • Transactions and positions in foreign currency should be converted into a single unit of account using the market exchange rate (see paragraphs 4.53–4.55).

  • Short-term maturity is defined as three months or less (or payable on demand), (see paragraph 5.93).

Underlying Series

7.4 The underlying series to be used in calculating individual FSIs are defined in Chapter 5. In describing the FSIs, some brief illustrations of the underlying series are introduced, together with cross-references to the more detailed definitions provided in earlier chapters. In this, and subsequent chapters, reference is regularly made to the financial statements presented in Chapter 5.

7.5 As presented in the Guide, FSIs are compiled at an aggregated sector level and constructed as ratios where numerator and denominator are the sum of each DT group’s underlying series. As such, they represent weighted averages for the whole financial system.5

Calculation of FSIs

7.6 Most FSIs consist of ratios of two underlying series. The calculation should use data with the same periodicity for both the numerator and the denominator, which, depending on the ratio being calculated, should be either flows recognized during the period, end-period, or average period positions.

7.7 The definitions underlying data series may differ across countries. Countries may also follow different conventions than those set out in the Guide. For transparency and cross-country comparability, the dissemination of FSI data should be accompanied of extensive metadata.

II. Core FSIs for DTs

7.8 The Guide recommends the compilation of 17 core FSIs for DTs (Table 1.1 of Chapter 1), which is a minimum set covering the most critical measures of financial soundness. However, for a more comprehensive assessment of the health of the financial sector, they should be complemented with additional FSIs, including for other sectors of the economy.6 Unless otherwise stated, all the “line” comments in this chapter refer to the financial statements and memorandum items of Table 5.1 in Chapter 5. Annex 7.1 summarizes the concepts, calculation methods, source data, and compilation issues of the core FSIs for DTs.7

Regulatory Capital to Risk-Weighted Assets

7.9 The FSI Regulatory capital to risk-weighted assets gauges DTs’ capital strength to withstand shocks and absorb unexpected losses. This FSI is based, as described in Chapter 3, on the definitions of total regulatory capital (line 39) and risk-weighted assets (RWA) (line 40).

7.10 Compilers will rely on national supervisory definitions of the components of capital and specification of risk weights. The metadata should identify: (i) which version of the Basel Capital Accord has been implemented in the jurisdiction; (ii) use, if any, of the various elements of national discretion in the Basel standards; and (iii) any variations from the applicable Basel standard (other than specified elements of national discretion).

7.11 This FSI is a ratio where the numerator is total regulatory capital and the denominator is onand off-balance-sheet assets weighted by risk. Total regulatory capital and RWA are defined in paragraphs 5.75–5.81 and paragraph 5.82, respectively, and use regulatory standards and concepts that do not correspond directly to balance sheet capital and assets.

7.12 Regulatory capital refers to a supervisory definition of capital developed by the Basel Committee on Banking Supervision (BCBS) and differs from accounting capital and reserve items. Current year results generally are excluded, while undisclosed reserves and valuation adjustments can be included in supplementary regulatory capital subject to specified restrictions. Goodwill, which is implicitly included in balance sheet capital, is deducted from regulatory capital. In addition, the definition adds several specified types of subordinated debt instruments that meet specified restrictions, as well as general provisions up to prescribed limits. Supervisory deductions are applied to the different components of regulatory capital, netting from its total. For a detailed treatment of the elements that constitute regulatory capital, see Chapter 3.

7.13 RWA refers to the DT’s risk-weighted assets (for credit, market and operational risks) and off-balance-sheet exposures. The adopted regulatory framework (Basel I, II, or III) determines the specific way of calculating RWA. Basel I adopted a straightforward and simple way of weighting the assets with five pre defined factors for credit risk. Basel II introduced additional factors and some revised risk weighting in the Standardized Approach as well as advanced approaches that measure risk based on internal models. Basel III introduced a more granular approach to risk weights and alternatives to the use of external ratings in the Standardized Approach.

7.14 The BCBS has prescribed minimum regulatory capital of 8 percent of RWA for all internationally active banks. Basel III effectively raises this minimum to 10.5 percent through the introduction of the 2.5 percent capital conservation buffer. National supervisors may require a higher ratio and have leeway in establishing the specific standards for their economies.

7.15 As with other FSIs, when analyzing this indicator, it is important to consider how numerator and denominator affect its value. A higher capital adequacy ratio can be achieved either by increasing the amount of capital, or by reducing RWA, which can be done by restructuring the portfolio toward less risky assets, for example, by reducing lending and increasing holdings of low risk-weight securities (see Box 7.1).

Tier 1 Capital to Risk-Weighted Assets

7.16 The FSI Tier 1 capital to RWA focuses on the core capital concept of the BCBS. Tier 1 capital is the most solid and readily available layer of regulatory capital, as it is considered permanent and absorbs losses by ranking last in the hierarchy of claims in the event of insolvency. Compared to the regulatory capital to RWA ratio, this FSI measures the most freely and immediately available resources to absorb losses.

7.17 This FSI is a ratio where the numerator is Tier 1 capital and the denominator is RWA. The concepts of Tier 1 capital (line 33) and RWA (line 40) are defined in paragraphs 5.76, 5.77, and paragraph 5.82, respectively, and are derived from regulatory standards and concepts that do not correspond directly to capital and assets shown in the balance sheet. Under Basel I and II, the minimum Tier 1 requirement is 4 percent of RWA, while Basel III increased it to 6 percent.

7.18 Source data are consolidated Tier 1 capital and consolidated RWA of each DT group in the reporting population. Data are based on supervisory concepts. The metadata provided should describe the national treatment in Tier 1 capital of equity investments in other banks, other financial institutions, and insurance corporations; since under the BCBS, such investments may be excluded from Tier 1 capital at the discretion of the national authorities. Metadata should also indicate other elements of national discretion and any variations, other than elements of national discretion, from the version of the capital accord applied in the jurisdiction.

Interpreting Regulatory Capital Trends

These graphical examples highlight how numerator and denominator affect the capital adequacy ratio, and the need to look into the underlying series when interpreting this and other FSIs.

The banking systems of both Country A and Country B improved substantially their capital adequacy from very low levels. However, while in Country A, the increase in the Regulatory capital to RWA ratio was achieved increasing the stock of capital while at the same time increasing exposure; in Country B, the increase in the ratio was done basically by reducing banks’ exposure through contracting lending and switching to less risky assets, such as government bonds. This can be seen observing the graphs on Total Regulatory Capital and RWA, with a base = 100 in the fourth quarter of Year 0.

Figure 7.1
Figure 7.1

Interpreting Regulatory Capital Trends

Source: IMF staff calculations.Note: RWA = risk-weighted asset.

Common Equity Tier 1 Capital to Risk-Weighted Assets

7.19 The FSI Common equity Tier 1 (CET1) capital to RWA measures the capital adequacy of DTs based on the highest-quality capital defined by Basel III, Common Equity Tier 1 (CET1).8 Countries that have not adopted Basel III are not required to compile this indicator. CET1 (which, together with additional tier 1 capital [AT1] is referred as “going-concern capital”) is the most loss-absorbing form of capital. It is a measure of the amount of capital available to a bank to absorb losses while continuing operations.

7.20 This FSI is a ratio where the numerator is CET1 capital and the denominator is RWA. The concepts of CET1 capital (line 34) and RWA (line 40) are explained in paragraphs 3.27 and 3.32–3.35, and defined in paragraphs 5.77 and 5.82. They follow regulatory standards and concepts and do not correspond directly to capital and assets shown in the balance sheet.

7.21 As specified in Chapter 3, Basel III splits Tier 1 capital into two components: (1) CET1 and (2) AT1. CET1 capital consists predominantly of common shares issued by the bank, stock surplus, retained earnings, and accumulated other comprehensive income and other disclosed reserves. AT1 capital consists of instruments that are subordinated, have fully discretionary non-cumulative dividends or coupons, and have neither a maturity date nor an incentive to redeem. Basel III established a minimum of 4.5 percent for the CET1 to RWA ratio.

7.22 Source data, based on supervisory concepts, are the consolidated CET 1 capital and the consolidated RWA of each DT group in the reporting population.

Tier 1 Capital to Assets and the Basel III Leverage Ratio

7.23 The FSI Tier 1 capital to assets provides an indication of financial leverage that is, the extent to which assets are funded by other than own funds. It is another measure of capital adequacy of the DT sector. This ratio serves as a supplementary measure to the risk-based capital requirements. An adverse trend in the ratio may signal increased exposure to risk and possible capital adequacy problems.

7.24 This FSI is calculated by using Tier 1 capital as numerator, and total (nonfinancial and financial) balance sheet assets—without risk weighting—as denominator. Unweighted assets are used in this ratio to provide insights into leverage. The concepts of Tier 1 capital (line 33) and total assets (line 14) are defined in paragraphs 5.76 and 5.77 and paragraphs 5.33–5.35, respectively.9

7.25 For jurisdictions that have implemented Basel III, this indicator would be calculated using the new Basel III leverage ratio, defined in paragraph 3.46. In this ratio, the capital measure for the numerator is Tier 1 capital. The denominator comprises a new Basel III aggregate called “exposure” consists of all balance sheet assets (with an add on for potential future exposures of derivatives and securities financing transactions) and off-balance-sheet exposures (Supervisory-based memorandum series).10 Off-balance-sheet exposures include commitments, unconditionally cancellable commitments, direct credit substitutes, acceptances, stand by letter of credit, trade letters of credit, failed transactions, and unsettled securities. Items that are deducted from capital are also deducted from the measure of exposure.

7.26 Regarding Tier 1 capital, source data and issues for compilers are discussed in the regulatory Tier 1 capital to RWA section. Data on total (financial and nonfinancial) assets are available from DTs’ balance sheets. The capital measure required by the Basel III leverage ratio can be obtained from supervisory sources.

Nonperforming Loans Net of Provisions to Capital

7.27 The FSI Nonperforming loans (NPLs) net of provisions to capital is intended to gauge the potential impact on capital of the portion of NPLs not covered by specific provisions. If there is appropriate recognition of NPLs, this ratio can provide an indication of the capacity of bank capital to withstand losses on loans identified as non-performing but not fully provisioned. While NPLs net of specific provisions is considered to be the best estimate of the realizable value of the NPLs, there is uncertainty until individual NPLs have been either fully collected, or all collection options have been exhausted and any unrecovered portion written of. Since the actual losses that will be incurred, and thus the realizable value of the NPLs are not known, the estimates of required provisions may vary from actual experience.

7.28 This FSI is calculated by taking the value of NPLs (line 49) less the value of specific loan loss provisions against NPLs (line 18.ii) as the numerator,11 and total regulatory capital as the denominator.

7.29 Loans are nonperforming when payments of principal and interest are past due by 90 days or more, or interest payments corresponding to 90 days or more have been capitalized, refinanced or rolled over. In addition, NPLs should also include those loans with payments less than 90 days past due, but for which evidence exists to classify them as nonperforming, such as if the debtor files for bankruptcy. After a loan is classified as nonperforming, it (or any replacement loan[s]) should remain so classified, until written-off or payments of interest or principal are received on this or subsequent loans that replace the original loan. Data on loans should exclude accrued interest on NPLs and lending among DTs in the reporting population that are part of the same group.12

7.30 Provisions are defined as specific loan loss provisions against NPLs. As described in Chapter 4, specific provisions refer to the portion of expected loss calculated for loans that are classified as impaired loans under IFRS9 or using an approach consistent with national supervisory guidance. The Guide relies on national practices in identifying specific provisions, which should be documented in the metadata. Provisions for the accrual of interest on NPLs should not be included under loan loss provisions, as they are identified within (and excluded from) net interest income.

7.31 Capital is measured as total regulatory capital (line 39 and defined in paragraph 5.75–5.80).13 In measuring sector-wide regulatory capital, intra-sector equity investments are deducted from the overall capital in the sector, so that capital and reserves held within the sector are not double counted. In line with supervisory guidance, capital excludes the value of goodwill.

7.32 Information on NPLs and specific provisions for the reporting population are typically available from supervisory sources, although national definitions of NPLs can vary.14 Similarly, regulatory capital data are available from supervisory sources.

7.33 The indicator requires the use of specific provisions when netting from NPLs. Some jurisdictions may not distinguish between specific and general provisions, which is consistent with the IFRS 9 ECL approach. This can result in negative values for the indicator if total (specific and general) provisions are higher than outstanding NPLs. In jurisdictions that do not allocate ECL to general and specific provisions, the subset ECL for non-performing loans, rather than total ECL, should be used if available to calculate the FSI, providing a more accurate indication of extent to which NPLs are covered by provisions. This emphasizes the importance of documenting national practices in the metadata if the dissemination of this FSI is not to be misleading.

Nonperforming Loans to Total Gross Loans

7.34 The FSI nonperforming loans to total gross loans is intended to identify problems with asset quality in the loan portfolio, with an increasing ratio signaling a deterioration in the quality of banks’ credit portfolio. For a proper interpretation, it should be used in combination with the FSIs NPLs net of provisions to capital ratio described earlier and Provisions to NPLs described further.

7.35 NPLs are identified only when problems emerge, so this FSI is a lagging indicator. Nevertheless, it shows a trend in the quality of DTs’ portfolio over time. Appropriate recognition of NPLs is essential for this ratio to be meaningful and cross-country comparable. The indicator can be viewed together with those for the nonfinancial corporate sector, as a deteriorating financial position for nonfinancial corporations might foreshadow future deterioration of this ratio. Moreover, this indicator can also provide insights into the buildup of systemic credit risk, allowing for benchmarking of financial systems in normal times with no stress, to monitor changes over time, and to compare across jurisdictions.

7.36 This FSI is calculated by taking the value of NPLs as the numerator and the total value of the loan portfolio (including NPLs, and before the deduction of specific loan loss provisions) as the denominator. Also, and as noted in paragraph 7.29, the denominator should exclude lending among DTs in the reporting population that are part of the same group. NPLs (line 49) and loans (line 18.i) are defined in paragraphs 5.94–5.96 and paragraphs 5.41 and 5.43, respectively.

7.37 The guidance on the definition of NPLs is the same as that provided for the previous FSI in paragraph 7.29. Total loans correspond to the balance sheet concept (after consolidation within the banking group) and include all loans to resident and nonresident institutional units. Data on performing and NPLs should exclude accrued interest on NPLs. Since the goal of this FSI is to gauge banks’ exposures arising from their loan portfolio, deposits with the central bank and other financial institutions should not be part of the denominator, even if national regulations allow to classify them as such.15

7.38 Information on loans should be available from the consolidated balance sheet of the reporting group and supervisory sources. Information on NPLs for the reporting population is typically available from supervisory sources, although national definitions on NPLs can vary. Equally, different legal frameworks may influence the length of time that NPLs must be kept on-balance sheet, distorting cross-country comparisons.16 For instance, if banks are not allowed to write-off loans—even when they are fully provisioned and the losses already absorbed—until a legally established time has lapsed; their balance sheets will indicate a more vulnerable situation than if those loans had been taken off-balance sheet, without any effect on the solvency of the institutions.

Provisions to Nonperforming Loans

7.39 The FSI provisions to NPLs gauges the extent to which NPLs are already covered by specific provisions. This ratio complements the information provided by the two previous FSIs on NPLs, providing a measure of the amount of future losses that would be incurred if all NPLs were written-off.

7.40 This FSI is calculated by taking the value of specific provisions against NPLs (line 18.ii) as the numerator, and NPLs as the denominator. NPLs and specific provisions are defined in paragraphs 5.94–5.96 and paragraph 5.48, respectively.

7.41 As noted earlier the loan loss allowance that are derived from the IFRS9 calculation are allocated to specific provisions and general provisions in line with national supervisory guidance. In jurisdictions that treat all ECL as specific provisions, the subset ECL for non-performing loans, should be used for calculating the FSI. This should be documented in the metadata.

7.42 Regarding NPLs and specific provisions, source data and compilation issues are discussed for the FSI nonperforming loans net of provisions to capital. Due to different national standards for the classification of loans as nonperforming and the constitution of loan loss provisions, data disseminated for this indicator should be supplemented with detailed metadata on national supervisory rules for treatment of collateral in determining required provisions. The discussion in the previous section on general provisions included indistinctly from specific provisions also applies here.

Loan Concentration by Economic Activity

7.43 The FSI Loan concentration by economic activity is aimed at gauging the credit risk associated with excessive concentration of credit in a specific domestic sector or activity. A large concentration of aggregate credit exposure to a specific resident economic sector or activity may signal an important vulnerability of the DT sector to the level of activity, prices, and profitability in that sector or activity. If conditions in sectors where banks have an excessive credit concentration deteriorate, the quality of their loan portfolio will suffer, with negative consequences for their financial health.

7.44 This FSI is the ratio of DTs’ lending to the largest three economic activities, as a proportion of their total gross loans to nonfinancial corporations. Lending by economic activity is based on the UN International Standard Industrial Classification of All Economic Activities, Rev 4 (ISIC Rev.4) at its higher level, which provides a widely accepted structure for the classification of economic activities. Box 7.2 presents a numerical example on how to calculate this indicator.

7.45 Data on loans are on a gross basis (i.e., before deducting specific loan loss provisions) and include NPLs. The availability of data on loans by economic activity might vary depending on supervisory practices, but it is expected that ISIC information will be readily available in most countries, facilitating cross-country comparability. If ISIC information is not available, an equivalent national classification by economic activity should be used and indicated in the metadata. Additional information on the three economic activities with the largest exposure will help interpret the results.

Return on Assets

7.46 The FSI return on assets (ROA) provides information on the DTs’ profitability relative to total assets and can be an indicator of how efficiently the DTs manage their assets to generate earnings. The ratio may be interpreted in combination with the FSI on return on equity (ROE) described further.

7.47 This FSI is the quotient of net income and total (financial and nonfinancial) assets. The preferred definition of net income is the one before taxes (line 8), as it is not affected by cross-country tax differences and, thus facilitates cross-country comparability. Net income and its components are defined in paragraphs 5.13–5.30. Total assets (line 14) are not risk weighted and correspond to the balance sheet concept as defined in paragraphs 5.33 and 5.35.

7.48 Being a ratio of a flow (income) to a stock (assets), this FSI is subject to different methods of calculation. Compilers should report the income annualization choice in the metadata. The denominator should be the average of the stock of total assets during the reporting period. At a minimum, the denominator can be calculated by using the average of the beginning and end-period positions, but compilers are encouraged to use the most frequent observations available for averaging.

Calculation of Loan Concentration by Economic Activity

The numerical example details the calculation of the FSI loan concentration by economic activity.

Source: IMF staff estimates.

7.49 The data for net income available from supervisory sources may depend on the national commercial accounting practice, as might the extent to which they meet the definitions in the Guide. Net income is calculated based on commercial accounting and supervisory approaches.

7.50 Net income, as defined in the Guide, includes gains and losses on financial instruments valued at fair value through profit and loss, and gains and losses from the sales of fixed assets, which are measured as the difference between the sale value and the balance sheet value at the end of the previous period. Notably, compilers should be aware that the Guide recommends that interest income not include the accrual of interest on nonperforming assets (paragraph 5.14). It also encourages the inclusion of realized and unrealized gains and losses arising during each period on all financial instruments (financial assets and liabilities, in domestic and foreign currencies) valued at FVTPL.

Return on Equity

7.51 The FSI return on equity (ROE) is intended to measure DTs’ efficiency in using capital. It also offers information on the ability of DTs to internally generate capital through retained earnings, and the attractiveness of the sector to new equity investment.

7.52 This FSI is the quotient of net income (flow) and total capital and reserves (stock) and therefore subject to different methods of calculations, which would produce different results. Compilers should report the income annualization choice in the metadata.

7.53 The Guide recommends net income after taxes (line 10), as this provides an indication of net operating income available for capitalization and profit distribution.

7.54 Net income and its components are defined in paragraphs 5.13–5.31. Capital is measured as total capital and reserves (line 31 and defined in paragraphs 5.70–5.72).

7.55 Differences in capital structure and business mix across countries affect bank performance and highlight the need to look at several operating ratios simultaneously. Banks with higher leverage (lower equity relative to assets) will generally report a higher ROE. Hence, an analysis of profitability based exclusively on ROE would tend to disregard the greater risks normally associated with high leverage. Regarding net income, data sources and compilation issues are discussed in the ROA indicator.

Interest Margin to Gross Income

7.56 The FSI interest margin to gross income measures the relative share of net interest income (interest earned less interest expenses) within gross income. This ratio is a gauge of the relative importance of the income generated by the intermediation business of DTs (mobilizing savings for investment).

7.57 This FSI is calculated by using net interest income (line 3) as the numerator and gross income (line 5) as the denominator. Net interest income and its components are defined in paragraphs 5.13–5.15, while gross income is defined in paragraph 5.16. Being a ratio of two flows, the Guide recommends accumulating the flows from the beginning of the year until the end of the reporting period.

7.58 Data for net interest income and gross income should be available from income statements and supervisory sources, but the extent to which they meet the definitions in the Guide could depend on national commercial accounting practice.

7.59 In the Guide, interest income should not include the accrual of interest on nonperforming assets (see paragraph 5.14). Gross income includes both net interest income and other gross income. As mentioned earlier, Other gross income items include realized and unrealized gains and losses arising during each period on all financial instruments (in domestic and foreign currencies) valued at FVPTL. Gains and losses on the sale of an associate or subsidiary (and disinvestment, of a reverse investment) are excluded from gross income (paragraph 5.19).

Noninterest Expenses to Gross Income

7.60 The FSI noninterest expenses to gross income measures the relation between non-intermediation expenses, often called overhead or operating expenses, and gross income (interest margin plus noninterest income). This FSI, often called the efficiency ratio, provides insights into the portion of gross revenues required to cover operating expenses, including personnel costs and occupancy expenses.

7.61 This FSI is calculated by using noninterest expenses (line 6 in Table 5.1) as the numerator and gross income (line 5) as the denominator. Noninterest expenses are defined in paragraph 5.25 and gross income in paragraph 5.16. The recommendation is for numerator and denominator to accumulate the flows from the beginning of the year until the end of the reporting period.

7.62 Noninterest expenses cover all expenses other than interest expenses. Provisions are not included in noninterest expenses but separately identified in the sectoral income and expense statement (line 7). Regarding gross income, issues for compilers are discussed in the interest margin to gross income summary.

7.63 The data for noninterest expenses and gross income available to supervisory sources may depend on national commercial accounting practice. Sources of gross income data are discussed in the section on Interest margin to gross income.

Liquid Assets to Total Assets

7.64 The FSI liquid assets to total assets provides an indication of the liquidity available to DTs to meet expected and unexpected cash outflows. The level of liquidity influences the ability of a banking system to withstand idiosyncratic funding shocks as well as more global market disruption.

7.65 This FSI is calculated by using the measure of liquid assets (line 47) as the numerator and total assets (line 14) as the denominator. Liquid assets are defined in paragraphs 5.90-5.92, and nonfinancial and financial assets are defined in paragraphs 5.33 and 5.35.

7.66 Data on liquidity should be available from supervisory sources. The extent to which national approaches to measuring liquidity meet the concepts in the Guide would require consideration. The available information may need to be aggregated to calculate both the numerator and denominator of this FSI.

Liquid Assets to Short-Term Liabilities and Liquidity Coverage Ratio

7.67 The FSI liquid assets to short-term liabilities is intended to capture the liquidity mismatch of assets and liabilities and provides an indication of the extent to which DTs could meet the short-term withdrawal of funds without facing liquidity problems.

7.68 This FSI is calculated by using the measure of liquid assets (line 47) as the numerator and the short-term liabilities (line 48) as the denominator. Liquid assets are defined in paragraphs 5.90–5.92, and short-term liabilities are defined in paragraph 5.93. Short-term liabilities are the short-term element (within three months or less) of DTs’ debt liabilities (line 28) plus the net market value of the financial derivatives position17 (liabilities line 29 less assets line 21); including liabilities to other D Ts in the reporting population.

7.69 Sources of data on liquid assets are discussed in paragraph 7.66. Data on short-term liabilities for all debt instruments are often available on an original maturity, but not always on a remaining maturity basis.18 Data on short-term liabilities on a remaining maturity basis might be available from supervisory sources. Data on financial derivatives should be available from accounting records and supervisory sources. The extent to which the data meet the concepts in the Guide, particularly about remaining maturity and financial derivatives, would require consideration. Any data should exclude positions within the same reporting group. The issues for compilers for liquid assets are the same as the ones described in the liquid assets to total assets section.

7.70 Jurisdictions that have implemented the liquidity standards of Basel III should compile both liquid assets to short term liabilities and the liquidity coverage ratio (LCR). If the LCR is applicable only to a subset of the DT sector, for example, large internationally active banks, the LCR should be compiled only for that subset. Liquid assets to short-term liabilities should continue to be compiled for the DT sector.

7.71 The LCR is an indicator of the ability of banks to survive a 30-day liquidity stress scenario. Te numerator is High Quality Liquid Assets (HQLA), defined as assets that would be liquid in times of stress and ideally, eligible collateral for central bank liquidity facilities (line 42, defined in paragraph 5.85). The denominator is net cash outflows arising from the application of supervisor-prescribed run-off rates to different categories of funding, and supervisor-specified assumptions regarding the availability of banks’ funding sources in the stress scenario (line 43, defined in paragraph 5.86).19 Annex 7.2 provides a numerical example on how to calculate the LCR for one illustrative bank.

7.72 Source data for LCR’s numerator and denominator are supervisory series reported in jurisdictions that have implemented Basel III. For the compilation of the indicator, data on HQLA and total net cash outflows calculated for each reporting group should be aggregated, to derive the ratio for the whole system. Application of the LCR will be challenging in many jurisdictions because of the dearth of highly rated assets traded in liquid markets that would meet the Basel definition of HQLA. This may result in national variations in definitions of HQLA. Also, there is no certainty that the Basel prescribed run-off rates and funding assumptions are appropriate for all jurisdictions, so these elements of the LCR may also be subject to national variations. The metadata should note any differences from the Basel LCR requirement in national implementation.

Net Stable Funding Ratio

7.73 The FSI net stable funding ratio (NSFR) replicates the indicator introduced under Basel III. It is an indicator of banks’ ability to withstand market disruption over a one-yeartime horizon. The NSFR is calculated by using the amount of available stable funding (ASF) (line 44, defined in paragraph 5.87) as the numerator, and the amount of required stable funding (RSF) (line 45, defined in paragraph 5.87) as the denominator.20 The BCBS minimum requirement is that this ratio should be equal to at least 100 percent on an ongoing basis.

7.74 ASF is the portion of capital and liabilities expected to be available to the bank to fund its operations over a one-year period. It is calculated by applying supervisor-prescribed factors, presumed to reflect the stability of liabilities, to banks’ liabilities and capital. There are five buckets with stability factors ranging from 100 percent (capital and borrowings with residual maturities of more than one year) to 0 percent (for highly volatile funding such as derivative liabilities).

7.75 RSF is measured based on the broad characteristics of the liquidity risk profile of an institution’s assets and off-balance-sheet exposures. It is calculated by applying supervisor-prescribed factors intended to approximate the amount of each type of asset and off-balance-sheet exposure that would have to be funded over a one-year period. The factors range from 0 percent for assets that are self-funded such as central bank reserves to 100 percent of assets encumbered for one year or more (and thus unavailable as liquid assets).

7.76 Source data for numerator and denominator are supervisory series reported in jurisdictions that have implemented Basel III. If the NSFR has only been applied to a subset of the sector, for example, large internationally active banks, the NSFR should be compiled only for that subset. For the compilation of the aggregated indicator, data on ASF and RSF calculated for each reporting group should be added, obtaining a ratio for the whole system. As with the LCR, elements of NSFR may be subject to national variations. Metadata should indicate if any elements vary from the Basel standard. Annex 7.3 contains a numerical example on how to calculate the NSFR for one institution.

Net Open Position in Foreign Exchange to Capital

7.77 The FSI net open position in foreign exchange to capital is intended to identify DTs’ exposure to exchange rate risk relative to capital. It measures the mismatch (open position) of foreign currency asset and liability positions to assess the potential vulnerability of the DT sector to exchange rate movements.

7.78 The most common measure of foreign exchange exposure is the net open position. Even if the sector as a whole does not have an open foreign exchange position, this might not be true for individual DTs or groups of DTs.

7.79 While a matched currency position will protect a DT against loss from movements in exchange rates, it will not necessarily protect its capital adequacy ratio. Even if a DT has a portfolio of foreign currency assets and liabilities that is completely matched, its capital/asset ratio will fall if the domestic currency depreciates.

7.80 To calculate this FSI, the numerator is either the net open position in foreign exchange for on-balance-sheet items (line 55) or the preferred approach using total (including off-balance-sheet items) net open position in foreign currency (line 56). Supervisory standards generally require inclusion of off-balance sheet items in the determination of net open position, so the total (line 56) will generally be available to compilers from supervisory sources. In disseminating data, it should be made clear which measure of the net open position is being employed. The denominator is total regulatory capital (line 39). Data for the net open position in foreign exchange and total regulatory capital from each reporting group should be aggregated to estimate the indicator for the whole system.

7.81 Deposit takers’ net open position should be calculated in accordance with BCBS guidance: it includes the sum of the net position of on-balance-sheet foreign currency debt instruments; net positions in financial derivatives; on-balance-sheet holdings of foreign currency equity assets; net future foreign currency income and expenses not yet accrued but already fully hedged; foreign currency guarantees and similar instruments that are certain to be called and are likely to be irrecoverable; and, depending on the national commercial accounting practice, any other item representing a profit/loss in foreign currencies of the foreign currency positions set out in a single unit of account. The Guide describes the sum of the first three items listed earlier as the “net open position in foreign exchange for on-balance-sheet items.” The extent to which the national approach to measuring the net open position varies from BCBS guidance should be disclosed in the metadata.

7.82 As described in paragraph 5.101, foreign currency items are those payable (receivable) in a currency other than the domestic currency (foreign currency denominated) and those payable in domestic currency but with the amounts to be paid linked to a foreign currency (foreign currency linked). Although by definition, gold held by DTs is a nonfinancial asset, due to its volatility and because DTs manage it similarly to foreign currency assets, the BCBS regards gold as foreign exchange when calculating this indicator.

7.83 To calculate the overall net open position, the nominal amount of the net position for each foreign currency and gold is first converted into the reporting currency using the spot rate.21 The overall net open position is measured then by adding the sum of the net short positions or the sum of the net long positions, whichever is greater, plus the absolute value of the net position in gold.22 In the example of Table 7.1, the net long position in foreign exchange results from adding the higher net open position (600 = 100 in yen + 200 in euro + 300 in pound sterling) and the absolute value of the net short position in gold (70), for an overall net open position of 670.23

Table 7.1

Example of Measuring the Net Open Position in Foreign Exchange

Source: IMF Staff estimates.

Annex 7.1 Summary of Core Financial Soundness Indicators for Deposit Takers

*Residential Real Estate Prices are addressed in Chapter 10.

Annex 7.2 Numerical Example of Liquidity Coverage Ratio

Note: The sum of total expected cash inflows is 2,650, but for calculating the liquidity coverage ratio they cannot be higher than 75 percent of cash outflows. HQLA = high-quality liquid assets.Level 2B HQLA is capped to 40 percent of HQLA.

Annex 7.3 Numerical Example of Net Stable Funding Ratio

Note: HQLA = high-quality liquid assets; LCR = liquidity coverage ratio; MDB = multilateral development banks; NDB = new development bank; PSE = public sector entity.

ANNEX 7.4 Islamic Deposit Takers and Financial Soundness Indicators

A. Introduction

7.84 This annex describes the business model of Islamic Deposit Takers (IDTs) and how IDTs’ financial instruments differ from conventional ones. The annex provides guidance to map IDTs’ source data to the necessary balance sheet and income statement templates used to compile FSIs for systems with Islamic banking.

B. Islamic Financial System

7.85 Islamic finance refers to the provision of financial services in accordance with Shariah principles.24 Shariah bans interest charges (Riba),25 products with excessive uncertainty (Gharar), gambling (Maysir), short sales, as well as financing of prohibited activities considered harmful to society. It also requires parties to honor principles of fair treatment and the sanctity of contracts. Transactions must be underpinned by real economic activities, and there must also be sharing of risks in economic transactions.

7.86 Shariah principles have existed throughout Islamic history but only began to be applied in modern Islamic financial systems in the early 1960s, with the establishment of Egypt’s Mitt Ghamar Savings Bank in 1963. Since then Islamic finance expanded rapidly in several countries in terms of value, market share, geographical reach, and number of institutions. As of end December 2017, Islamic banking had become systemically important in 13 jurisdictions, including Sudan and the Islamic Republic of Iran whose entire banking systems are Islamic banking.26

Islamic Deposit Takers’ Structures

7.87 Islamic financial systems structures can be grouped into two broad categories:27

  • (a) A dual system, where both conventional deposit-takers (DTs) and IDTs coexist. The IDTs can be stand-alone entities, subsidiaries of conventional banks, or “Islamic windows.”28 Not all dual systems allow “Islamic windows” (e.g. Bahrain and Jordan).

  • (b) A full-fedged Islamic financial system with virtual absence of conventional DTs, where only full-fledged IDTs are licensed to operate – for example, in the Islamic Republic of Iran and Sudan.

7.88 The principles underpinning Islamic finance generate distinct operations and risk profiles and balance sheet structures that differ in important respects from conventional banks.29 The differences may affect the compilation and meaning of the FSIs. Although the international prudential and accounting standards that apply to conventional banks are relevant, in significant measure, for IDTs, there is a need for some adjustments to address the specific features of DTs.

7.89 Standards for the Islamic banking industry have been developed in recent years to complement international conventional banking standards. Specifically, the Islamic Financial Services Board (IFSB)30 has established standards and principles on the regulation and supervision of Islamic financial intuitions and activities, including on capital adequacy, governance, risk management and the supervisory standards to supplement the Basel Committee on Banking Supervision (BCBS). In addition, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)31 has issued standards on accounting, auditing, governance, ethics, and Shariah standards on Islamic financial institutions. In order to harmonize the compilation of FSIs, this annex builds on the standard-setting framework for conventional banks.

C. Islamic Finance Business Model

7.90 Since IDTs are prohibited to pay interest, they are funded by financial instruments without a promised ex-ante return (e.g, Qard, Wadiah, or Amanah), as well as profit sharing investment accounts (PSIA) where investors receive returns that are determined ex post by the profitability of the IDT or the pool of assets financed by these accounts. Correspondingly, on the asset side, IDTs do not engage in interest-based lending, but in “financing” in the form of sales, lease, profit and loss-sharing financing, and fee-based services. On the treasury side, Islamic banks are restricted or prohibited, in many jurisdictions, from undertaking certain types of derivatives; as a result derivatives and hedging instruments tend to have limited and slowly developing markets.32

7.91 In addition to non-remunerative contracts such as Qard, Wadiah, and Amanah, IDTs earn income by charging fees for services (Wakala), by sharing profit (Mudaraba) or by leasing (Ijarah). Under a Wakala (agency) structure, an investor receives a profit return agreed between the parties at the outset; any profit in excess of the agreed return will be kept by the agent as a performance or incentive fee. In contrast, under a Mudaraba structure, profit/loss is divided between the investor and the bank according to pre-agreed ratios.

7.92 Under profit and loss sharing (PLS) arrangements, the resources of the IDTs and investors are often pooled to undertake commercial ventures, and the total returns are shared among the IDTs and the investors based on a predetermined profit sharing arrangement. Profits earned could be disbursed during the life of the venture or upon its conclusion. These arrangements can also be generated by issuing securities, called PLS certificates (often classified as “other Shariah-compliant securities” – that is ‘other than Sukuk), that do not provide for either capital certainty or pre-fixed positive returns.

7.93 Profit and loss sharing activities are a distinguishing feature of the use of funds by IDTs, as the basis of Islamic finance is risk-sharing between the parties in an underlying asset-based transaction. IDTs use various Shariah compliant contracts (mode of finance or instrument) or, sometimes combination of contracts, when offering a spectrum of financial structures. The three broad modes of finance are:

  • (a) Sale-based contracts: IDTs provide immediate delivery of the goods or services sought by the customers in exchange for the customers promising to make a series of deferred payments to the IDTs equal to the cost of the goods or services plus a markup;

  • (b) Lease-based contracts: IDTs purchase assets and lease them to the customers in return for instalments that reflect the cost of holding and maintaining the assets; and

  • (c) Equity-based or PLS contracts (Mudaraba and Musharaka): IDTs provide funds to an enterprise in return for a share of the profits generated by these PLS arrangements. Mudaraba contracts will be operated by the enterprise with remuneration of the IDT based on preagreed distributions of profits or losses, whereas Musharaka contracts a more fully partnership arrangements in which the IDT can participate in the enterprise’s decision making.

7.94 The boxes 7.3. and 7.4. present a comprehensive list of Islamic financial instruments33 and discuss their classification in the balance sheets and income statements of IDTs relative to those of conventional deposit takers.

D. The Capital Adequacy Requirements for Islamic Deposit Takers34

7.95 The computation of capital adequacy ratios (CAR) is similar to the BCBS formulae, but there are important variations in the recognition of eligible capital, risk-weighted assets, and the treatment of PSIA. In line with the global standard, the IFSB has provided more comprehensive guidance.

Eligible Capital

7.96 The definition of regulatory eligible capital to be used as the numerator in calculating the CAR is defined in Chapter 5. The PSIA are analogous to deposits and they should not be included in capital because they do not meet the requirement to constitute additional Capital (Tier 2).35 The investment equalization reserves (IRR) and a portion of the profit equalization reserves (PER) that belong to the equity of investment account holders (IAH) are not part of the capital of the IDTs.36 As the purpose of a PER is to smooth the profit payouts and not to cover losses, any portion of a PER that is part of the IDTs reserves should also not be treated as part of the regulatory capital of the IDTs.

7.97 Some types of Sukuk might qualify for inclusion in regulatory capital. Subject to Shariah approval, Musharaka Sukuk may be included as Additional Tier 1 if they meet loss-absorbency requirements. Also, Mudaraba or Wakala Sukuk may qualify as Tier 2 capital, if the underlying assets are convertible into common equity at the point of non-viability or insolvency.

Risk-weighted Assets

7.98 Islamic financial instruments are asset-based (Murabaha, Salam, and Istisna’a), equity-based (Musharaka and Mudaraba), leasing-based (Ijara), or Sukuk. The asset-based instruments bear market risk on the underlying assets and credit risk in respect to the counterparties. The risk exposure of an IDT transforms from market risk to credit risk when an asset is sold to its customer (Murabaha) as the price risk of holding that asset ceases and is replaced by credit risk. Risk-weighting requirements for equitybased instruments are based on credit risk requirements if they are loan-like instruments and market risk requirements if they are equity-like instruments. Sukuk may also be subject to differing approaches to risk-weighting. Sukuk held in the trading book are subject to credit and market-risk weighting requirements aligned with those for conventional instruments. For the Sukuk held in the banking book, the supervisory authorities have discretion to allow the IDTs that operate within their jurisdictions to specify the internal-rating based measurement approach to be used.

Profit Sharing Investment Accounts Treatment

7.99 A major difference between IDTs and conventional DTs relates to PSIA loss absorbency. Unless the IDT is guilty of misconduct or negligence, IAH are expected to bear the loss of earnings or investments that were made with their funds, but the IDT bears the costs of operations and thus might experience a net profit or loss. For the calculation of CAR, the IFSB standard provides two formulas: standard and discretionary. In the standard formula, the risk-weighted assets (RWA) exclude the assets financed by PSIA. The second formula, referred to as the supervisory discretionary formula, is designed to account for displaced commercial risk (DCR) as determined at the supervisor’s discretion. The DCR is a risk specific to the Islamic banking that rises when an IDT is under pressure to pay its IAHs a rate of return higher than would be payable under the “actual’ terms of the investment contact in order to remain competitive relative to other banks and thus retain customers. The IDTs have discretion to set aside some portion of the profits under special types of reserve, namely, PER to mitigate the DCR. Hence, instead of excluding all the funds that belong to the PSIA from RWA, only a portion adjusted for the DCR is excluded because it can be borne by the IDT.37 In some jurisdictions, the adjustment is made simply on the expectation that the IDT should carry greater amounts of capital as a protection for depositors. This portion of RWA is arbitrarily denoted by the Greek letter α “alpha”. The quantification and use of this alpha parameter in the CAR calculation is subject to supervisory discretion and differs considerably across jurisdictions.

Source of Funds

Source: IMF staff estimates.Note: AAOIFI FAS = Accounting and Auditing Organization for Islamic Financial Institution Financial Accounting Standard; IDT = international development targets; IFI = international financial institutions.

The line items correspond to the Table 5.1 in Chapter 5.

In some jurisdictions, this type of deposits is part of IDTs general pool.

The proposed classification is consistent with the current position of Task Force of the Islamic Financial Services Board (IFSB) on the Prudential and Structural Islamic Financial Indicators (PSIFIs). However, the classification of the Hibah under L.2 or L.6 depends on the underlying attributes of the Hibah whether it is paid on a regular and/or a nonvoluntary basis (L.2) or not (L.6).

A Mudarib is the party in the Mudaraba contract who provides the expertise to manage the capital with the purpose of earning profit that will be shared with the fund provider per a mutually agreed proportion

Uses of Funds

Source: IMF staff.Note: AAOIFI FAS = Accounting and Auditing Organization for Islamic Financial Institution Financial Accounting Standards; IDT = international development targets; IFI = international financial institutions.

The line items correspond to the Table 5.1 in Chapter V.

Tawarruq is used on both sides of the IDT balance sheet, for financing and deposits addressing various liquidity needs of the transacting parties. On the deposit side Islamic banks use Commodity Murabaha as a deposit mobilizing fund, where the client has excess liquidity and is looking for fixed return on it. In this case the client firstly buys a commodity and sells it to the IDTs on deferred basis. Effectively the client made a placement that resembles a fixed income deposit since he will be now receiving a fixed return. This structure in also known as a Reverse Tawarruq.

7.100 Due to the national discretion in the various implementation of Basel standards, the compilers will rely on national standards for the FSIs computation and should document in the metadata any departures. At time of publication, Islamic banks in various jurisdictions operate under Basel I, Basel II, or Basel III – the standard used should always be described in metadata.

E. Financial Soundness Indicators for Islamic Deposit Takers

7.101 The limited availability of statistical information on the Islamic financial services industry worldwide has hindered accurate and comprehensive analysis and assessment of developments in the industry. More specifically, the lack of cross-country historical data with sufficiently long time-series has been identified as one of the major challenges faced by the IFSB in developing its international prudential standards.

7.102 For this reason, the IFSB has developed FSI equivalents for IDTs—Prudential and Structural Islamic Financial Indicators (PSIFIs).38 The PSIFI Compilation Guide was issued in 2008 and revised in March 2011. Furthermore, in November 2014 a supplement for the PSIFI Compilation Guide was issued to update the list of indicators to be compiled by IDTs under the IFSB’s project on the implementation of PSIFIs.

7.103 The changes in the list of PSIFIs reflect lessons learned during the global financial crisis that began in 2007, revisions to global regulatory framework in Basel III and corresponding IFSB standards, modifications to the list of IMF’s FSIs, proposals by the Statistical, Economic, and Social Research and Training Centre for Islamic Countries (SESRIC), and experiences of the IFSB and IMF in working with countries to compile and disseminate soundness indicators.

7.104 The prudential indicators are divided into core indicators and additional indicators. The core indicators, which closely correspond to the Core FSIs specified in the Guide, are commonly used banking indicators, and are analyzed in the IFSB’s annual Islamic Financial Services Industry Stability Report.39 The set of core indicators includes series related to Basel III items or which have demonstrated importance during the crisis. The structural indicators are indications of the size and structure of the Islamic banking sector. The IFSB recommended that all countries with Islamic banking should compile separate sets of prudential and structural indicators for stand-alone IDTs and Islamic windows of conventional DTs because of differences in their capital structure and liquidity arrangements. All the indicators remain the same for IDTs and Islamic windows except for some difference in the structural indicators.

F. Mapping Islamic Deposit Takers’ Financial Statements40

7.105 This section provides guidance on how to map the financial information from the IDTs income statement, balance sheet, and other related information to the FSI’s financial statements for deposit takers (income statement, balance sheet, and memorandum series) as recommended in this Guide.

7.106 Due to differences in business models across IDTs and DTs, some core FSIs for DTs, such as the margin between interest receipts and payments income and expense, do not apply to IDTs. However, for countries with dual DT systems, in order to compile the system’s FSIs, there is a need to map the Islamic financial instruments to the conventional ones. For example, the profits generated from loan and deposit-like instruments and Shariah-compliant securities, will be analogous to interest income/expense.

7.107 The reporting of the financial statements and the FSIs should be based on the table 5.1 of Chapter 5 which is intended to provide guidance to countries in preparing and producing the aggregated financial statements and the memorandum series for the whole deposit takers sector that encompass both IDTs and DTs. To ensure cross-country comparability Table 7.1 shows a suggested mapping of Islamic instruments to the required line items of the Table 5.1. These suggested items in italic format as mentioned in Table 7.1 are not to be reported but are shown as a guidance for compilers.

7.108 The mapping set out in the Table 7.1. specifies the data sources to draw from for the compilation of the full range of FSIs in this Guide. One key challenge is the classification of the PER and IRR. Unlike conventional banks, the IDTs undertake some risk-sharing activities with their fund providers and/or depositors. For harmonizing the FSIs compilation, it is necessary to consider the specificities of the Islamic finance and to classify the PER and IRR to best equivalent financial instruments. For the FSIs compilation, these instruments should be associated with their PSIA, under deposits.

7.109 One key issue in the compilation of FSIs for IDT is how to classify the returns on deposits/financing, financial lease, and Islamic bonds (Sukuk) as interest. In this section, as Islamic rules and principles (Sharia), prohibits usurious payment (riba), including predetermined returns on borrowed funds. Therefore, for FSI purposes, the term adopted to distinguish the Islamic return from conventional interest is “financing and investment income.41

7.110 Some of the series required to calculate the FSIs are not directly available from the financial statements. They are included as memorandum items to the financial statements. The supervisory-based items for the IDTs series are different from those of conventional banks, regarding the CAR. Although the Basel Capital Accord was not intended for IDTs, the IFSB developed a parallel Capital Adequacy Standard (CAS) for IDTs. Table 7.1 highlights selected memorandum series that require additional guidance information for compiling these series for the IDTs.

Table 7A.1

Islamic Deposit Taker

Source: IMF staff.Note: IRR = investment risk reserve; PER = profit equalization reserve; PSIA = profit sharing investment accounts.

The purpose of this Table is to provide guidance for national compilers in preparing for the IDTs the Table 5.1 of Chapter 5.

The line-item series in this table are equivalent to those reported in the Table 5.1 of Chapter 5 which are required to be reported by the national compilers.

The details of the calculation are in Annex 5.2 of the Monetary and Financial Statistics Manual and Compilation Guide.

In some jurisdictions, net income should also exclude Zakah payment, which is obligatory payment made under Shariah on certain kinds of property and used for charitable and religious purposes. Its treatment in the financial statements should be analogous to tax.

Only selected memorandum series are shown from Table 5.1 Chapter 5 that require additional guidance for IDTs.

1

Some countries may also benefit from EBA Guidance Note on Compiling the IMF Financial Soundness Indicators for ‘Deposit‐ Takers’ using the ITS on Supervisory Reporting, https://eba.europa.eu/documents/10180/1460270/EBA+Guidance+Note+on+compiling+IMF+FSIs+%28July+2018+update%29.pdf/d2e22fc2-6602-4dd0-ad45-a914955f6883.

2

The consolidation adjustments performed within the reporting groups will depend on the consolidation basis used to compile FSIs (see Chapter 6).

3

In the terminology of the IFRS 9, these are instruments held to collect their contractual cash flows.

4

Specific provisions are a memorandum series derived from the IFRS 9 calculation of expected credit loss (ECL), with the loan loss allowance allocated to specific provisions and general provisions in line with national supervisory guidance as described in Chapter 4. See BCBC Regulatory treatment of accounting provisions—interim approach and transitional arrangements (March 2017).

5

The same FSIs recommended in the Guide for the whole sector can be compiled at the individual group level to support banking supervision.

6

These additional FSIs are presented in Chapters 8, 9, and 10.

7

Annex 7.4 describes the business model of Islamic Deposit Takers and provides guidance on how to map the financial information from the Islamic Deposit Takers’ income statement and balance sheet to those of DTs to assist in the compilation of system FSIs for countries with dual DT systems.

8

See Chapter 3, paragraphs 3.25–3.31.

9

The 2006 Guide recommended to use balance sheet capital as numerator. This option is eliminated.

10

See paragraph 3.46.

11

NPLs and specific provisions are defined in paragraph 5.94 and paragraph 5.48, respectively. The dissemination of data for this indicator should be supplemented with detailed metadata on national supervisory rules for classifying loans as nonperforming and for collateral.

12

See Chapter 5, paragraph 5.94 to paragraph 5.96.

13

Where a Domestic Location (DL) consolidation is used, countries have the flexibility to use total capital and reserves (line 31, defined in paragraphs 5.70–5.72) as denominator, because foreign-owned branches might not be required to hold regulatory capital.

14

When national definitions deviate from the one presented in the Guide, they should be documented in the metadata.

15

For instance, the EU Commission Implementing Regulation 2015/1278 includes as banks’ exposures cash balances at central banks and other demand deposits. This treatment artifcially inflates the denominator. Therefore, countries should follow the Guide definition and exclude such deposits when compiling this FSI.

16

For this, and other cases where national frameworks differ, the availability of metadata is crucial for the interpretation of the indicators.

17

The net market value position (liabilities less assets) of financial derivative liabilities should be included rather than the gross liability position. This is because of the market practice of creating offsetting contracts and the possibility of forward-type instruments switching between asset and liability positions from one period to the next.

18

The IMF External Debt Statistics—Guide for Compilers and Users (2013) outlines the presentation of remaining maturity data for banks, on an external debt basis only.

19

See BCBC Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools (2013).

20

See BCBS Basel III: The Net Stable Funding Ratio (2014).

21

Where a DT is assessing foreign exchange risk on a cross-border consolidated basis, it may be technically impractical in the case of some marginal operations to include the currency positions of a foreign branch or subsidiary of the DT. In line with BCBS guidance, in such cases, the internal limit in each currency may be used as a proxy for the positions.

22

See BCBS, 2005, Amendment to the Capital Accord to Incorporate Market Risk, Basel, p. 25. This method is called the “shorthand” method by the BCBS. At supervisory discretion, DTs could use internal models.

23

This calculation method supersedes the recommendation of the 2006 Guide, which calculated the numerator netting positive and negative open positions in foreign currencies and gold.

24

The industry is termed “participation finance” or “noninterest-bearing finance” in some jurisdictions.

25

Riba is an Arabic word, which is generally translated into English as “usury” or “interest.”

26

The Islamic Financial Services Board (IFSB) defines systemically important to be 15 percent or more of total banking system assets.

27

See the Revised Compilation Guide on Prudential and Structural Islamic Financial Indicators, March 2011.

28

An Islamic Window is a department, branch, or other dedicated unit of a conventional bank that offers Islamic financial services.

29

For an elaboration of the unique risks posed by Islamic Finance, see IMF Staff Discussion Note. Islamic Finance: Opportunities, Challenges and Policy Options SDN/15/05.

30

The IFSB, which is based in Kuala Lumpur, Malaysia, is a global standard setting body for Islamic finance, which prepares prudential standards and guidelines for the regulation of banking, capital markets and Islamic insurance ( T a k a f u l) . It was officially inaugurated on November 3, 2002 and started operations on March 10, 2003.

31

The AAOIFI is a standard setting body for Islamic finance, which prepares accounting, auditing, and Shariah standards. It was established in 1991 and is based in Manama, Bahrain.

32

The permissibility of Islamic banks to conduct derivatives transaction is subject to the Shariah rulings in a particular jurisdiction. In some jurisdictions it is permitted for banks to use derivatives transactions for hedging purposes. The derivatives are generally structured using Tawarruq and other parallel contracts.

33

The annex only discusses the main Islamic financial instruments and for FSI compilation.

34

This section draws on Chapter 6 of the Revised Compilation Guide on Prudential and Structural Islamic Financial Indicators, March 2011, and on IFSB-15: Revised CAS for institutions offering Islamic financial services (excluding Islamic insurance ( Takaful) institutions and Islamic collective investment scheme, December 2013.

35

The requirements are loss absorbency, issuance process and procedure, maturity and callable option, distribution of profits, and unsecured in nature.

36

Profit equalization reserves (PER) are allocated from operating income for smoothing returns to funders, prior to deducting the Mudarib’s (IDT’s) share. Investment risk reserves (IRR) are set aside from the income share of investment account holders as a cushion for future losses that they may incur.

37

IFSB Guidance Note 15 provides more details.

38

See the Revised Compilation Guide on Prudential and Structural Islamic Financial Indicators, March 2011.

39

The IFSB also developed a series of structural indicators for IDTs to capture information on features of Islamic banking sectors not otherwise available; number of institutions, number of windows, total assets, total revenues, earnings, financing by type of Islamic financial instrument, assets of systemically important IDTs, etc.

40

This section draws on Chapter 4 of the Revised Compilation Guide on Prudential and Structural Islamic Financial Indicators, March 2011.

41

Under the auspices of the Inter Secretariat Working Group on National Accounts (ISWGNA) work is ongoing to reconcile the classification of the property income associated with Islamic financial instruments as interest within the System of National Accounts (SNA) and the prohibition of interest in the Shariah law.

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