Risk Management in
Islamic Financial Instruments
122
contracts more than the modern contracts. Mudarabah, Musharakah and Murabahah are the
three partnership contracts that are severely affected by the four categories of risk. In
addition, mark up risk has special implications for Murabahah.
A lack of understanding, limited use of technology, limited or no diversification across various
products and regions, among others, are the major problems identified by the bank managers.
Also, bank managers identified limited securitization and the unavailability of Islamic money
market instruments as barriers to efficient liquidity management. The Islamic regulatory
system is inadequate to reduce problem loans. IFIs have already established risk reporting
systems. However, country risk was not analyzed and reported, as many IFIs are not globally
diversified. Bankers did not use technology to manage risks. Many of the modern tools were
unknown to IFIs. Operating risk was reported very poorly.
Most of these banks have used AAOIFI risk management guidelines and the guidelines
suggested locally by the central banks. Since many countries did not have sufficient Islamic
banking regulations, a portion of these banks opted to use other internationally accepted
standards of risk management and reporting systems. Two thirds of the bankers had active
engagement in research and development in order to identify problems beforehand. Bankers
do believe that Basel regulations are only partially applicable to IFIs. Hence, there is need for
full-fledged Islamic regulation of risk management and control.
This study offers a risk management framework showing that IFIs are the strongest
institutions in risk management if they make use of the Shari’ah-based banking system. Islamic
Shari’ah is the core risk management system, which is also supported by internal and external
control mechanisms. Many of these controls are absent in conventional financial system. This
study suggests investing in the training of employees, investment in education and technology,
investment in relationship building with other banks and customers, and diversification of
banking operations among like-minded neighboring countries. Risk management operations
must be robust to the changes in banking operations. Eventually, the stability of banking
operations should be given higher importance than the size of operations.