Fitch Ratings has affirmed the Islamic Development Bank’s (IsDB) Long-term Issuer Default Rating (IDR) at AAA with a stable outlook and short-term IDR at F1+.
IsDB’s ratings are underpinned by strong intrinsic features, primarily excellent capitalisation. IsDB is one of the most highly capitalised multilateral development banks (MDBs) rated by Fitch. The ratio of equity to assets has remained above 60% since inception (61.1% at end-1433H, equivalent to 14 November 2012 in the Gregorian calendar); mainly thanks to regular capital inflows from shareholders and steady yet moderate profits. The ratio of debt to equity is low, at 57.5% at end-1433H. The bank also maintains a comfortable level of liquid assets, which more than fully covered its short-term liabilities at end-1433H.
Credit risk is moderate. The IsDB mainly extends project financing guaranteed by member states or state-owned banks to finance infrastructure or social services. Due to compliance with Islamic finance principles, most financing is asset-backed. As with other MDBs, activity is mostly focused on speculative grade borrowers (67.4% at end-1433H) but the bank benefits from preferred-creditor status on sovereign-guaranteed operations, therefore keeping impaired operations at a minimum. The five largest borrowers accounted for 35.2% of equity at end-1433H, a lower level than most peers.
Fitch deems other risks under control. Credit risk on treasury assets is mitigated by recourse to short-term investments in a diversified range of instruments and banks. Interest rate risk and foreign exchange risk are strictly hedged. The bank’s risk on equity investments is higher (equity stakes and fund participations accounted for 14.3% of total operations at end-1433H) but remains manageable given the bank’s long-term investment horizon and comfortable cushion of equity.
Shareholders’ support is also supportive of the rating. IsDB’s capital is owned by 56 countries, all members of the Organisation of Islamic Cooperation, which have committed to provide callable capital if the bank should require it to honour its liabilities. Although the proportion of highly rated callable capital is lower than for peers (with 43.4% of callable capital being rated ‘AA-‘ or above at end-1433H), willingness to support is strong as illustrated by continuous capital inflows to the bank and the significant capital increase recently approved by IsDB’s board of governors.
The bank undertook countercyclical action in 2009-2011, significantly expanding its loan portfolio. The pace of its operational expansion has recently subsided. However, helped by its recent capital increase, the bank plans to use its capital resources more intensively over the coming years. Although this could put pressure on capitalisation and leverage indicators, Fitch expects the IsDB to stand by its governance principles and cautious prudential framework.
The stable outlook reflects Fitch’s expectation that IsDB’s financial profile will remain commensurate with the ‘AAA’ rating. Given that IsDB’s ratings are not driven by support, a moderate weakening in the credit quality of the shareholders would not jeopardise the ratings.
Downward pressure on IsDB’s ratings would occur if Fitch observed a pronounced deterioration of asset quality or a sudden and unexpected deterioration in capitalisation and leverage.