IFSB approves technical note for stress testing Islamic financial service providers

The Council of the Islamic Financial Services Board (IFSB) has approved the adoption of a new technical note for stress testing institutions offering Islamic financial services (IIFS).

The Technical Note on Stress Testing for IIFS (TN-2) aims to provide regulatory and supervisory authorities (RSAs) and market players of the Islamic banking industry with the appropriate technical guidance to develop, conduct and assess stress tests. The document addresses multiple types of risks and their interrelated effects on the overall financial position and performance of the portfolio, institution, group or system. These risks include, but are not limited to, credit risk within financing portfolios, market risk on assets held, foreign exchange risk, liquidity risk, rate of return risk, as well as discussions on aspects of sharīʻah non-compliance risk.

Specifically, TN-2 aims to:

• Facilitate the design and simulation of solvency and liquidity stress tests for IIFS, including providing guidance on establishing macrofinancial links, running scenarios of various assumptions and stress parameters;
• Highlight the specificities of risk exposures in IIFS and how they need to be captured in stress-testing exercises; and
• Provide stylised numerical examples of IIFS stress tests under different shock scenarios.

TN-2 offers five basic stress test templates: one each for conducting credit, market and liquidity risk assessments, as well as for rate of return risk, and a scenario analysis template that combines credit and market risk stress tests. The proposed basic stress test templates 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 industry-wide level.

The scope of TN-2 is limited to the banking sector and covers both institutional-level (i.e. tests used by institutions to assess their risk tolerance and capital level) and industry-wide stress tests (i.e. those used by regulatory and supervisory authorities (RSAs) as a supervisory tool for financial stability analysis stress testing). RSAs may extend the application of TN-2 to Islamic “window” operations that are self-contained, or modify it for application to other types of IIFS that fall within their jurisdictions.

The application and implementation of TN-2 is subject to the adoption of other applicable IFSB Standards and Guiding Principles – in particular, IFSB-12: Guiding Principles on Liquidity Risk Management for IIFS; IFSB-13: Guiding Principles on Stress Testing for IIFS; and IFSB-16: Revised Guidance on Key Elements in the Supervisory Review Process of IIFS. The TN also complements IFSB-17: Core Principles for Islamic Finance Regulation (Banking Segment), which aims to assist the surveillance and assessment of Islamic banking sector.

Interested?

The soft copies of TN-2 will be available on the IFSB website in both English and Arabic.