Annexure 1 — List of eligible collaterals and Valuation Frequency
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Eligible Collaterals
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Collateral is an efficient tool for reducing credit risk. The fundamental role of any collateral is to mitigate the loss which may occur if the counterparty defaults on its obligation. The following list includes examples of eligible collateral (not comprehensive or exhaustive list) used for calculation of provisions and should be subject to the finance company's policy.
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| | — | Cash
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| | — | Gold
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| | — | Realizable amount of bank deposits
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| | — | Certificate of deposits
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| | — | Government securities, treasury bills, Government bonds and SUKUKs
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| | — | Shares of listed companies and government related corporates
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| | — | Corporate bonds/sukuk with a minimum of investment grade rating
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| | — | Receivables
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| | — | Financial guarantees e.g., Sovereign guarantees, Bank guarantees and Kafalah guarantees;
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| | — | Immovable collateral - immovable object, an item of property that cannot be moved without destroying or altering it — a property that is fixed to the earth, such as land or a house.
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| | — | Other physical collateral - physical collateral other than immovable property.
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| | — | Treating lease exposures as collateralized - exposure arising from leasing transactions as collateralized by the type of property/asset leased.
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Finance companies should clearly document in collateral policies and procedures the frequency of collateral valuations. The policies and procedures should also provide for the following:
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| | a. | Companies monitor the value of each type of collateral on a defined frequent basis.
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| | b. | More frequent valuations where the market is subject to significant negative changes and/or where there are signs of a significant decline in the value of an individual collateral.
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| | c. | Defined criteria for determining that a significant decline in collateral value has taken place. These will include quantitative thresholds for each type of collateral established, based on the observed empirical data and qualitative experience, taking into consideration relevant factors such as market price trends or the opinion of independent appraisers or valuers.
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| | d. | Appropriate haircuts to cover, at a high level of confidence, the maximum expected decline in the market price of the collateral asset, over a conservative liquidation horizon before a transaction can be closed out, in order to cover potential declines in collateral values during liquidation. The haircut adjusted collateral values should be considered for the purpose of calculating Loss Given Default (LGD).
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| | e. | Stress-tests and scenario analysis on finance companies portfolio of collateral in order to assess the impact under unusual market conditions (e.g. a significant decline in property or vehicle prices).
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Valuation Frequency
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Immovable Collateral
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Immovable collateral relating to Stage 3 or Default Exposures should be re-valued once every year such that the collateral value used in the calculation of Loss Given Default (LGD) for Stage 3 exposures should not be more than 12 months old at the reporting date. The valuation should be carried out by licensed and approved appraisers or valuers fulfilling requirements of law of commercial pledge. The valuation report should clearly indicate therein, amongst others, the present market value and the forced sale value. In cases, where judgement is used in the valuation of collateral, valuations should be carried out by more than one external appraisers and lower of the two values should be taken into consideration.
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Finance Companies should continuously monitor general trends in markets (e.g. property price) and take into account any deterioration or obsolescence of the collateral. For exposure classified as Stage 1 and Stage 2, finance companies should assess on annual basis whether the immovable collateral needs to be assessed by approved appraisers, e.g., where the collateral coverage is low and there is an indication of significant decline in the value of the asset. The assessment and related conclusions should be documented and endorsed by the Audit Committee of the company. A more conservative approach should be adopted while considering collateral values for the purpose of LGD calculations where up to date or recent collateral valuations are not available.
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Other Physical Collateral Including Leased Assets
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Finance companies should re-value other physical collateral including leased assets (other than immovable collateral) at least on an annual basis. Collateral should be valued, at net realizable amount, being the current market value less any potential realization costs (e.g. carrying costs of the repossessed collateral, legal fees or other charges associated with disposing of the collateral in the event of foreclosure). Finance companies may use a combination of external (market values from independent appraisers or Price Quotes from Seller/ manufacturer for specialized assets) and internal valuation methods (e.g., written down value). The valuation methods used should be based on assumptions that are both reasonable and prudent and clearly documented. A more conservative approach should be adopted for valuing collateral relating to Stage 3 or Default exposures and an appropriate haircut to the estimated market value should be applied where appropriate.
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