Gain insight into the unique risk management challenges within the Islamic banking systemRisk Management for Islamic Banks: Recent Developments from Asia and the Middle East analyzes risk management strategies in Islamic banking, presented from the perspectives of different banking institutions. Using comprehensive global case studies, the book details the risks involving various banking institutions in Indonesia, Malaysia, UAE, Bahrain, Pakistan, and Saudi Arabia, pointing out the different management strategies that arise as a result of Islamic banking practices. Readers gain insight into risk management as a comprehensive system, and a process of interlinked continuous cycles that integrate into every business activity within Islamic banks.
The unique processes inherent in Islamic banking bring about complex risks not experienced by traditional banks. From Shariah compliance, to equity participation contracts, to complicated sale contracts, Islamic banks face unique market risks.Risk Management for Islamic Banks covers the creation of an appropriate risk management environment, as well as a stage-based implementation strategy that includes risk identification, measurement, mitigation, monitoring, controlling, and reporting. The book begins with a discussion of the philosophy of risk management, then delves deeper into the issue with topics like:
Risk management as an integrated systemThe history, framework, and process of risk management in Islamic bankingFinancing, operational, investment, and market riskShariah compliance and associated risk
The book also discusses the future potential and challenges of Islamic banking, and outlines the risk management pathway. As an examination of the wisdom, knowledge, and ideal practice of Islamic banking,Risk Management for Islamic Banks contains valuable insights for those active in the Islamic market.
Preface xv
Acknowledgments xxi
About the Authors xxiii
List of Acronyms xxv
PART ONE Introduction
CHAPTER 1 Principles of the Islamic Financial System 3
Islamic Financial Contracts: The li-tabarru Contract versus li-tijari Contract 3
Principles of Islamic Finance 5
Interest-Based Return versus ProfitLoss Sharing 6
CHAPTER 2 The Islamic Bank and Risk Management 9
Differences between an Islamic Bank and a Conventional Bank 10
History of the Islamic Bank 11
Global Islamic Banking Entities 12
Risk as an Integral Part of Islamic Bank 16
Stages in Risk Management 20
Risk and Return Trade-Off 27
Various Approaches on Risk Identification 28
The Importance of Risk Management for an Islamic Bank 28
PART TWO Risk Management Framework in Islamic Banking
CHAPTER 3 History of Risk Management in Islamic Banking 33
Basel I and Its History 34
Basel II and Its History 36
Basel III and Its History 40
The AAOIFI and Its Role 43
The IFSB and Its Role 44
CHAPTER 4 The Risk Management Process in Islamic Banking 47
Risk Management Model in Islamic Banks 47
Risk Identification Process in Islamic Banking 56
Risk Matrix 57
Risk Mitigation Process 61
Risk Review Process 62
Infrastructure and Facilities 62
Calculation of Minimum Capital Requirements 66
CHAPTER 5 Financial Reporting and Analysis in Islamic Banking 72
The Importance of Financial Statements in Risk Analysis 72
Scope of Financial Statement in Islamic Banks 74
Basic Contracts and Instruments in the Islamic Bank 78
Structure of the Balance Sheet 80
Analysis of Income Statement 87
Persistence Analysis 88
Tools of Financial Statement Analysis 89
Core Business Activity in Islamic Banks 92
Off-Balance Sheet Activity in Islamic Banks 101
PART THREE Risk Management in Islamic Banking
CHAPTER 6 Financing Risk in Islamic Banking 107
Urgency of Financing Risk Management in Islamic Banking 107
Characteristics of Islamic Financing Contracts 108
Financing Risk: Definitions and Its Scope 110
Role of Rahn and Kafalah 112
Defining Determinant Factors of Financing Risk 114
Urgency of the Independent Rating Agency 128
Rating and Financing Risk Provisions 130
Risk-Based Financing Limit 133
Concentration Risk in Financing Portfolio 133
Financing Portfolio Management 135
Measuring Financing Risk in the Islamic Bank 139
CHAPTER 7 Operational Risk in Islamic Banking 144
Urgency of Risk Awareness 144
Operational Risk Coverage in Islamic Banks 145
Identification of Operational Risk Factors 149
Operational Risk in Islamic Financial Contracts 155
Measurement of Islamic Operational Risk 160
Developing an Operational Risk Management System 166
CHAPTER 8 Syariah Compliance Risk 168
Basic Principles of Islamic Economics and Financial System 169
Syariah as Principle and Spirit in Business 170
Various Prohibitions in Muamalah 172
Why Should Islamic Banking Comply with Islamic Principles? 175
Integrating Syariah Compliance in the Islamic Bank 176
Evolution of Syariah Governance in Islamic Financial System 177
Syariah Advisory Board and Syariah Compliance Audit as a Framework 179
Identification Process of Syariah Compliance Risk 183
Risk Management and Mitigation of Syariah Compliance Risk 187
Models of Syariah Governance in Several Countries 188
CHAPTER 9 Strategic Risk 194
Definition and Scope of Strategic Risk in Islamic Banking 195
Determinants of Strategic Risk and Its Mitigation 196
Issues Related to Strategic Risk 204
CHAPTER 10 Investment Risk in Islamic Banking 209
Syirkah as a Distinct Trait of Islamic Banks 209
Basic Concept of Investment Risk 210
Forms of Risk and Their Mitigation 216
Regulations on Profit Distribution Management 230
CHAPTER 11 Market Risk in Islamic Banking 232
Urgency of Market Risk 233
Scope of Market Risk in Islamic Banks 234
Identification of Market Risk Profile 239
Market Risk Measurement in Islamic Banks 244
Market Risk Mitigations in Islamic Banking 253
Implementation of Market Risk Mitigation 256
CHAPTER 12 Liquidity Risk in Islamic Banking 264
Urgency of Liquidity Risk 264
Credit Multiplier, Financial Stability and Liquidity Crises 265
Definition and Coverage of Liquidity Risk 267
Islamic Banks Assets and Liabilities 271
Liquidity Risk Management in Islamic Banks 272
PART FOUR Future Prospects and Challenges in Islamic Banking
CHAPTER 13 Development of the Islamic Financial Market 285
Islamic Capital Market 286
Derivative Islamic Market 292
Regulation and Supervisory in Islamic Financial Market 294
Institutional-Based Development Framework 295
Stability in Islamic Financial System: Lesson from Global Financial Risk 296
CHAPTER 14 Development of a Pricing Model in Islamic Banking 299
Fundamentals in Islamic Pricing Model 299
Time Value of Money in Pricing Model 302
Current Islamic Pricing Model 305
Urgency of Pricing Mechanism in Islamic Banks 314
CHAPTER 15 Pathways of Risk Management in Islamic Banks 315
Islamic Banks as Real Implementation of Risk Management 315
Challenges of Islamic Banking in the World 317
Blueprint for Islamic Banking Regulation 319
Prospects and Challenges of Islamic Banking Development 323
Strategic Issues in the Implementation of Islamic Risk Management 324
CHAPTER 16 Future Agenda 328
Landscape of Integrated Islamic Risk Management 329
Synergy and Integration among Islamic Financial Institutions 330
Competency and Competitiveness of Islamic Banking 331
Regulatory Agenda in the Future 333
Anticipating the Potential Systemic Risks 335
PART FIVE Conclusion
CHAPTER 17 Summary and Conclusion 345
Glossary 350
Bibliography 359
Index 383
