5. Market Risk

Effective from Dec 02 2021 - Apr 30 2022
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5.1	Principle 2.0: Banks shall have in place an appropriate framework for market risk management (including reporting) in respect of all assets held, including those that do not have 2 ready market and/or are exposed to high price volatility.
5.2	Banks shall develop a market risk strategy including the level of acceptable market risk appetite taking into account contractual agreements with fund providers, types of risk- taking activities and target markets in order to maximize returns while keeping exposures at or below the pre-determined levels. The strategy should be reviewed periodically by the Bank, communicated to relevant staff and disclosed to fund providers.
5.3	Banks shall establish a sound and comprehensive market risk management process and information system which (among others) comprise:
	•	a conceptual framework to assist in identifying underlying market risks;
	•	appropriate frameworks for pricing, valuation and income recognition;
	•	a strong MIS for controlling, monitoring and reporting market risk exposure and performance to appropriate levels of senior management.
	Given that all the required measures are in place (e.g. pricing, valuation and income recognition frameworks, strong MIS for managing exposures etc.), the applicability of any market risk management framework that has been developed should be assessed taking into account of consequential business and reputation risks.
5.4	Banks should be able to quantify market risk exposures and assess exposure to the probability of future losses in their net open asset positions.
5.5	The risk exposures in the investment securities are similar to the risks faced by conventional financial intermediaries, namely market price, liquidity and foreign exchange rates. In this regard, Banks shall ensure that their strategy includes the definition of their risk appetite for these tradable assets.
5.6	In the valuation of assets where no direct market prices are available, Banks shall incorporate in their own product program a detailed approach to valuing their market risk positions. Banks may employ appropriate forecasting techniques to assess the potential value of these assets.
5.7	Where available valuation methodologies are deficient, Banks shall assess the need (a) to allocate funds to cover risks resulting from illiquidity, new assets and uncertainty in assumptions underlying valuation and realization; and (b) to establish a contractual agreement with the counterparty specifying the methods to be used in valuing the assets.
5.8	The policies and related procedures for market risk management shall also account for the risks associated to the following Shari’ah compliant products:
	•	The risks that relate to the current and future volatility of market values of specific assets (for example, the commodity price of a Salam asset, the market value of a Sukuk, the market value of Murabahah assets purchased to be delivered over 2 specific period) and of foreign exchange rates.
	•	In salam, Banks can be exposed to counterparty credit risk on a long position and commodity price fluctuations while holding the subject matter until it is disposed of. In the case of Parallel salam, there is also the risk that a failure of delivery of the subject matter would leave the Banks exposed to commodity price risk as a result of the need to purchase a similar asset in the spot market in order to honor the Parallel Salam contract.
5.9	When Banks are involved in buying assets that are not actively traded with the intention of selling them, it is important to analyze and assess the factors attributable to changes in liquidity of the markets in which the assets are traded and which give rise to greater market risk. Assets traded in illiquid markets may not be realizable at prices quoted in other more active markets.
5.10	Banks are also exposed to foreign exchange fluctuations arising from general FX spot rate changes in both cross-border transactions and the resultant foreign currency receivables and payables. These exposures may be hedged using Shari'ah compliant methods.
5.11	In addition to the above, there should be a middle office or an independent function to perform market risk management function and to independently monitor, measure and analyze risks inherent in the treasury operations of a Shari'ah compliant Banking. In addition, the unit should also prepare control reports indicating deviations for the information of senior management.