Risk Management in
Islamic Financial Instruments
17
securities in the conventional space are a claim against a pool of assets, whereas in Islamic
finance, they are claims to individual assets. This promotes equity participation. In addition,
these Islamic assets are of relatively low risk, because they are collateralized against one, real
asset (Hawary, Grais, and Iqbal, 2003). Ijara (Islamic leasing) and istisna*7 are the underlying
contracts (respectively) that generate many collateralized Islamic securities. Usually, they have
longer maturities than asset-backed securities. Another sub-class of transactional contracts in
Islamic finance is musharaka, a form of Islamic contract that is, for all intents and purposes,
similar to mudaraba, except participation is more equitable with regards to labor, which is
provided jointly by the involved parties.
2.3 STRUCTURE AND FINANCIAL INTERMEDIATION PRACTICES OF IFIS
Now that we have defined the principal Islamic contracts underlying the types of financial
activities outlined by a theoretical, two-tiered Islamic balance sheet (based on the “two
windows” model discussed below), it is important to cover how those contracts are applied
within the scope of the theoretical balance sheet of an Islamic bank found outlined next
(Greuning and Iqbal, 2008). Note that the liabilities side is divided into two deposit windows:
demand deposits and investment/special investment accounts.
On the asset side, there is:
Conventional practice Islamic method
Short-term trade finance Murabaha; Salaam
Medium-term investments Ijarah; Istisn’a
Long-term partnerships Musharakah
Fee-based services Joala; Kifala; etc.
On the liabilities side:
Conventional practice Islamic method
Demand Deposits Amanah
Medium-term investments Mudarabah
Long-term partnerships Mudarabah; Musharakah
*The liabilities side also includes reserves and equity capital
See below Figure 2.2, another, more visual description of Islamic contracts and their linkages
to Islamic finance. 8
7 *Differs from ijara; pre-ordered production of an entity, with the raw materials provided by the buying agent.
8 Exhibit 2.3, “Islamic banking: Risk and contractual role” from Hawary, Dahlia El, Wafik Grais, and Zamir Iqbal. "Regulating Islamic Financial
Institutions: The Nature of the Regulated." International Conference on Islamic Banking: Risk Management, Regulation and Supervision, Aug.
2003.