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technology and operating procedures. A major portion of the banks did not have computerized
risk management systems. These banks did not diversify their investments across countries,
did not use loan grading mechanisms, and did not monitor the changes in the benchmarks that
decide the rate of return for the stakeholders. Over half of these banks do not produce a
country risk report. Risk monitoring has been very traditional in many banks. These banks use
financial performance-based monitoring mechanisms. Another half of these banks did not
continuously reappraise the value of collateral. Due to the lack of understanding of risk
management practices and the limited use computer systems, most of the modern risk
identification and management techniques could not be used. Traditional risk identification
and management techniques, such as the internal rating system and maturity matching for
liquidity management, are commonly used. Most of the banks are using financial reporting
guidelines by either AAOIFI or a system that is locally established by modifying international
standards. With minor exceptions, most of the banks already have strong internal control
systems, even though they are not very happy with the existing risk management system in
place. Bankers argued that the capital requirement for IFIs should be different than that of
conventional institutions. The system initiated by the Basel committee may not be directly
used in IFIs.
IFIs are resilient to conventional risk not because of the internal control systems or assistance
provided by external stakeholders. It is resilient because of the Shari’ah principles. These
principles are at the core of Islamic risk management. Additionally, the Shari’ah supervisory
board actively monitors the introduction and operation of new products. These actions are
absent in conventional system. Hence, it is important to understand the basic norms of
Shari’ah that will help this system to thrive on its own, instead of waiting for the proactive
mechanism that may not yield any positive result.
CHAPTER 6: CONCLUSION
Islamic financial institutions are exposed to risks pertaining to the investments and the
financial products and services that they engage in. The degree of risk exposure varies from
product to product, because of their underlying contractual format.
In a Murabahah contract, the bank takes possession of the asset and, at least theoretically, the
bank holds the asset for some time. This holding period is almost eliminated by the Islamic
banks by appointing the client as an agent for the bank to buy the asset. In an Istisna contract,
enforceability becomes a problem, particularly with respect to fulfilling the qualitative
specifications. To overcome such counterparty risks, Fiqh scholars have allowed band al-jazaa
(penalty clause). In several contracts, a rebate on the remaining amount of mark-up is given as
an incentive for enhancing repayment. Fixed rate contracts such as long maturity instalment
sales are normally exposed to more risk, as compared to floating rate contracts such as
operating leases.
Islamic financial institutions can engage in two broader sets of risk management techniques.
The first type in comprised of standard techniques, such as risk reporting, internal and
external audit, GAP analysis, RAROC, and internal rating. The second set includes techniques