Risk Management in
Islamic Financial Instruments
26
capital measurement approaches and the associated disclosures. Another important point he
makes is that given the special nature of investment accounts, with its links to return on assets,
fostering adequate Asset Liability Management, ALM, is critical. Though in the absence of
hedging instruments and rate of return benchmarks, effective ALM would require the
appropriate development of asset securitization, the promotion of Islamic Money markets
through novel uses of such securitization, and the establishment of bench mark rates of
returns using effective monetary operations.
Generally, financial system infrastructure needs to be strengthened in order to provide a
stronger platform for market development and to facilitate effective risk management. This,
according to Sundarajan, should be accomplished in several steps. Capital markets need to be
fostered with an emphasis on asset securitization by developing the needed preconditions
relating to governance, accounting, and creditor rights. This would facilitate the securitization
of bank loans and the development of investment account products as claims on such
securitized asset pools, whose risk levels can then be made transparent and closely managed.
Islamic Money markets and systemic liquidity arrangements should also be strengthened.
Additionally, Sundarajan (2002) cited that disclosure regimes for IFSIs need to become more
comprehensive and transparent, with a focus on disclosures of risk profile, risk-return mix and
internal governance. He states that proper coordination of supervisory disclosure rules and
accounting standards, and proper differentiation between consumer friendly disclosures to
assist investment account holders, and market-oriented disclosures to inform markets would
allow for such transparency. Supervisory review process should also monitor and recognize
the extent of risk sharing by investment account holders in assessing capital adequacy. This
would encourage more effective and transparent risk sharing with investment account
holders. Specifically, he mentions that appropriate disclosure of risks borne by PSIA and
shareholders should be a requirement for granting capital relief on account of PSIA. The
measurement of these risks, and estimation of appropriate capital relief can be based on the
VAR methodology as discussed in his work.
Discussed in the next to sections of this paper are risk issues as they apply specifically to two
“household” Islamic mechanisms, takaful and sukuk, as well as Islamic microfinance, a
burgeoning subsector of the IFI industry.
2.5 SUKUK MARKET RISK
Sukuk are arguably the most well-known of the Islamic financial mechanisms discussed in this
paper. Though it may seem counterintuitive, the development of the sukuk market has both
allowed for an alleviation of certain risks, but has also created a new set of issues of its own.
Two types of sukuk are relevant to this discussion, asset-backed and asset-based sukuk
(Dusuki and Mohktar, 2010). Please see below, a chart depicting various classifications of these
two kinds of sukuk.