Region

Jurisdiction

Regulator

2023-07-12

Circular 13/2022: Instructions for Calculating Capital Adequacy for Islamic Banks

The Central Bank of Libya issued Circular 13/2022 to mandate the implementation of capital adequacy calculation instructions for Islamic banks in accordance with IFSB standards and Basel II requirements. The directive requires commercial banks operating in Libya to comply with these regulatory controls starting March 31, 2023, with a transition period for data submission ending June 30, 2023. It establishes the framework for measuring credit, market, and operational risks using standardized and basic indicator approaches to ensure alignment with international banking standards.

Libya

Central Bank of Libya

Central Bank of Libya

P.O. Box 11103, Al-Sawani, Misratah - Tripoli - Libya

Memorandum No. (2022/15)

Date: 25 Jumada al-Awwal 1444 AH Corresponding to: December 19, 2022 AD

Reference No.: 804

To: Chairmen of the Boards of Directors of Banks To: General Managers of Banks

Subject: Circular on Instructions for Calculating Capital Adequacy for Islamic Banks

Based on the provisions of Law No. (1) of 2005 concerning Banks and its amendments, and in accordance with the standards issued by the Islamic Financial Services Board (IFSB) regarding the measurement of capital adequacy for Islamic banks, And referring to Memorandum No. (17/96) dated 22/8/1996 concerning capital adequacy, and completing the supervisory instructions issued by the Banking and Currency Supervision Department to analyze and avoid risks, and in light of the application of the latest banking supervision definitions and instructions.

Preamble: Therefore, we transmit to you the instructions for calculating capital adequacy according to the requirements of the standards issued by the Islamic Financial Services Board (IFSB) regarding the measurement of capital adequacy for Islamic banks, in order to commence their implementation, within the competencies of the unit for applying the instructions of the Basel Committee on Banking Supervision referred to in Memorandum No. (2022/7), and to provide us with the results achieved.

Peace be upon you...

Taj Muhammad Isa Director of the Banking and Currency Supervision Department

Copy to: Mr. / The Governor Mr. / Deputy Director of the Banking and Currency Supervision Department Mr. / Deputy Director of the Banking and Currency Supervision Department for Office Supervision and Follow-up Mr. / Deputy Director of the Banking and Currency Supervision Department for Auditing Mr. / Deputy Director of the Banking and Currency Supervision Department for Islamic Form Issues Mr. / Managers of Compliance and Commercial Banks Departments Mr. / Managers of Risk Departments in Banks

Basel Instructions

www.cbl.gov.ly . swift code: CBLJLYLX , +218 21 444 1488 : Fax , +218 21 333 3591 : Telegram

Central Bank of Libya

CENTRAL BANK OF LIBYA Banking and Currency Supervision Department

Instructions for Calculating Capital Adequacy for Islamic Banks

1- Objectives of the Standard:

This standard is one of the most important tools of banking supervision, and aims to address the risks of some Islamic financing forms and their relationship with the capital adequacy equation, including regulatory capital and associated risks. The objectives of its application are as follows:

Unifying methods for measuring risks for Islamic banks, and determining risk weights for Islamic financial products and services.
Developing the operations of Islamic banks to enable them to meet the requirements of Basel II decisions and comply with international standards.
Improving the quality of assets and increasing equity in Islamic banks, and increasing the trust of customers dealing with these Islamic banks.

2- Scope of Application of the Standard:

This standard applies to calculating the capital adequacy ratio for Islamic banks according to Basel II requirements to enable Islamic banks to comply with international standard requirements.
Commercial banks operating in the Libyan banking sector must comply with the supervisory controls of the capital adequacy standard as of March 31, 2023, noting that several transitional periods have been determined with a deadline of June 30, 2023, during which banks will submit their data according to the controls.
The capital adequacy ratio standard is prepared quarterly (every three months) and the results are sent to the Banking and Currency Supervision Department.

3- Calculation of the Minimum Capital Adequacy Ratio:

Measuring the minimum capital adequacy requirements is done by measuring the minimum capital adequacy for Islamic banks using the general capital adequacy framework adopted by the Basel Committee, which links regulatory capital to risk-weighted assets (financing risks + market risks + operational risks) according to the following equation:

Capital Adequacy Ratio =

Eligible Capital = Tier 1 Capital + Tier 2 Capital (minus deductions from capital)

a- Components of Tier 1 Capital:

Paid-up capital
Disclosed reserves (i.e., reserves consisting of real profits and disclosed in published accounts), including:
- Legal Reserve - General Reserve
- Special Reserve - Emergency Reserve
- Carried Profits (Losses)
- Share Premium
Other reserves of the same nature (including any reserves formed from real profits and disclosed along with their movements)
Minority interests (contribution of other parties to the capital of companies owned by the bank)

b- Components of Tier 2 Capital:

Undisclosed reserves (consisting of real profits but not disclosed in final accounts)
45% of the asset revaluation reserve or secret reserves (name: fixed assets) General Financing Provision (provided that the portion added to Tier 2 Capital does not exceed the limit)
1.25% of total risk-weighted assets on and off the balance sheet.
Subordinated loans (including long-term loans obtained by the bank from its shareholders for a period of at least five years).

c- Deductions from Capital:

Capital is reduced by the following items:

Deficiency in the provision for non-performing loans (the difference between the actual provision balance in the balance sheet and the required provision according to Central Bank of Libya circulars regarding non-performing loans and provisions)

1-3-1 Calculation of Eligible Capital:

Eligible capital (the numerator of the ratio) is calculated following the definition set by the Basel Committee for regulatory capital, where regulatory capital according to the Basel Committee definition consists of two parts (the first part is called Tier 1 Capital) and (the second part is called Tier 2 Capital), taking into account the constraints and violations set by the Committee, expressed as follows:

Eligible Capital = Tier 1 Capital + Tier 2 Capital (minus deductions from capital)

a- Components of Tier 1 Capital:

Paid-up capital
Disclosed reserves (i.e., reserves consisting of real profits and disclosed in published accounts), including:
- Legal Reserve - General Reserve
- Special Reserve - Emergency Reserve
- Carried Profits (Losses)
- Share Premium
Other reserves of the same nature (including any reserves formed from real profits and disclosed along with their movements)
Minority interests (contribution of other parties to the capital of companies owned by the bank)

b- Components of Tier 2 Capital:

Undisclosed reserves (consisting of real profits but not disclosed in final accounts)
45% of the asset revaluation reserve or secret reserves (name: fixed assets) General Financing Provision (provided that the portion added to Tier 2 Capital does not exceed the limit)
1.25% of total risk-weighted assets on and off the balance sheet.
Subordinated loans (including long-term loans obtained by the bank from its shareholders for a period of at least five years).

c- Deductions from Capital:

Capital is reduced by the following items:

Deficiency in the provision for non-performing loans (the difference between the actual provision balance in the balance sheet and the required provision according to Central Bank of Libya circulars regarding non-performing loans and provisions)

1-2-1 Calculation of Risk-Weighted Assets (Denominator of the Ratio):

The total risk-weighted assets (denominator of the capital adequacy ratio) according to Basel II requirements include financing risks + market risks + operational risks, and each type of risk is measured using several measurement methods ranging from simple to complex methods based on the level of development, and appropriate measurement methods are used after obtaining approval from the supervisory authority.

2-2 Risk Measurement Methods:

The standards of the Islamic Financial Services Board (IFSB) have been adopted, which were based on Basel II proposals and covered financing risks and operational risks, in addition to amendments regarding the introduction of market risks into Basel (I) decisions. Some necessary amendments have been introduced to Basel (II) to build upon the characteristics of Islamic products.

The simple method was used to measure risks.
The standardized method was adopted to measure financing risks.
The Basic Indicator Approach was adopted for the modified measurement of operational risks.
For measuring market risks (Standardized Method, Simple Method).

3-2 Measurement of Credit Risk:

Direct financing (on-balance sheet) and indirect financing (off-balance sheet) operations are the most important sources of credit risk, as they result in the possibility of customer default. To measure financing risks, the standardized method is used for ease of application.

3-2 Measurement of Credit Risk:

Direct financing (on-balance sheet) and indirect financing (off-balance sheet) operations are the most important sources of credit risk, as they result in the possibility