Risk Management in
Islamic Financial Instruments
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controlled by un-Islamic principles. However, Islamic banks should operate solely based on the
Shari’ah.
(e) Going back to basic – Shari’ah based versus Shari’ah compliant
Gradually, IFIs must have a plan to go back to Shari’ah based risk management systems. As
illustrated in Figure 4.12, Shari’ah based financial operations is the first line of defense. If IFIs
sacrifice in the first line of defense, the rest of the system will collapse. Hence, the most
important element of risk management in IFIs is to bring back the wisdom of Shari’ah into
operations.
(f) Diversification
IFIs are still struggling to diversify their portfolio of operations across countries, sectors and
industries. Perhaps it is easier to diversify across industries and sectors. However, IFIs have to
ensure that there exist experts on those sectors and industries among the staff who can guide
the risk management process for that specific sector. In fact, IFIs should have experts on each
sector or industry they are dealing with. This goes back to the notion of having effective
training for employees.
(g) Role conflict: social versus operational
It is important to understand that the risk management division exists solely for the purpose of
operational sustainability. It may not yield any social value addition in the immediate term.
Islamic banks are more closely tied to social development goals than conventional banks.
However, the objective of the risk management division is to make IFIs fit for social
development. Hence, there should not be any role conflict between the overall objective of the
IFIs and the specific objectives set for the risk management division.
(h) Investing in education system
In order to get good employees, many IFIs are now directly connected to educational
institutions. They are financing studies by brilliant students and bringing them into the
banking sector after the successful completion of their studies. Some of these educational
institutions are specialized in banking and financial sector education. IFIs may offer cases to
discuss in universities in order to build awareness about risk management practices and
strategies. As the Islamic financial system is relatively new, there is a need for an integrative
approach between the banks and the regulators in order to bring a proactive, long-term
change in the way we see risk management today.
(i) Legal system
IFIs are lucky if they are in a system that does not tolerate habitual defaulters. Banks must
assist the government and the regulatory authority in introducing a healthy legal atmosphere
for all. In many countries, there is no Islamic banking law to guide the IFIs. In addition to the
ordinary legal system, IFIs must work out an operating practice that abides by the laws of
Shari’ah.