RISK IN ISLAMIC BANKS: EVIDENCE FROM EMPIRICAL RESEARCH BY NORAINI MOHD. ARIFFIN AND SIMON ARCHER Prepared by: Noor Fadhlika Mohd Ramlan 0723118 Nursyakilla Lokman 0823280 Nur Suhailah Mohd. Safaai 0823796 Nurul Izzati Mohd. Aminuddin Zaki 0838968
Nov 10, 2014
RISK IN ISLAMIC BANKS: EVIDENCE FROM EMPIRICAL
RESEARCH BY NORAINI MOHD. ARIFFIN
AND SIMON ARCHER
Prepared by:Noor Fadhlika Mohd Ramlan 0723118
Nursyakilla Lokman0823280Nur Suhailah Mohd. Safaai 0823796
Nurul Izzati Mohd. Aminuddin Zaki0838968
INTRODUCTION
Unique characteristics of Islamic Banks: profit-sharing loss-bearing
Transparent in reporting risks because Investment Account Holder (IAH) need to:
Monitor their investment Assess potential risks and rewards Protect their interest
RISK IN ISLAMIC BANKS
2 dimensions
of risks
Prohibition of Gharar
Freedom of contract
- Excluding riba and gharar
Gambling
• Creation of risks for chance of very high gain
• Zero-sum game (create no wealth)
Risk taking
• Part of the real economic activity that creates economic value
• Permissible and desirable
• Asymmetric information problem• Capital Impairment RiskCredit Risk• Cannot hold return-producing cash
equivalents• Lack of sufficient Shari’a compliant liquid
instrumentsLiquidity Risk
• Currency fluctuationsCurrency Risk
• Not ApplicableInterest-rate Risk
Risk of trade and
investmentFiduciary Risk – operational risk or the risk of breach of the Mudaraba contract or misconduct or
negligenceDisplaced commercial risk – rate of return risk
RESEARCH METHODOLOGY
Questionnaire survey & contacting the banks directly
(e-mail or post)
Sample – 28 Islamic banks in 14 countries
RESEARCH METHODOLOGY (CONT)
How does the risk perception of Islamic bankers differ from
conventional bankers with respect to the market in
which Islamic banks typically operate?
Do Islamic banks use the more technically
advanced risk measurement techniques?
Apart from using similar risk mitigation approaches as in conventional banks, do Islamic banks widely use Shari‘ah-compliant
risk mitigation approaches?
Which risk mitigation process used by
conventional banks are not used by Islamic banks?
RESEARCH QUESTIONS
PROPOSITION
Proposition 1 – Salam and Istisna’a are perceived as
more risky than Murabaha and Ijarah
Proposition 2 – Profit-sharing contracts (Musharaka and
Mudaraba) are perceived as more risky than mark-
up based contracts (Murabaha, Salam,
Istisna’a, and Ijarah)
Proposition 3 – Not many Islamic banks use the
more technically advanced risk measurement approaches
Proposition 4 – Islamic banks use a number of risk mitigation methods that are different from
methods used by conventional banks, as they are designed to be
Shari’a compliant
1- RISK PERCEPTIONS CONT. Finding shows that;
PROPOSITION 1 is supported by the findings since both Salam and Istisna’a contracts are riskier than Ijarah and Murabahah.
PROPOSITION 2 is partly supported by the findings because Mudarabah and Musharakah is perceived to be riskier than Murabahah and Ijarah and Istisna’a, not to Salam.
Mudarabah and Musharakah contribute to the banks earnings, but they attract more risks to the banks.I. Rate of return risk;II. Liquidity risk;III. FOREX risk; andIV. Operational risk
1- RISK PERCEPTIONS CONT. All countries opinion that credit risk is
the most important risk.Consistent with the study in conventional
banks.Basel Committee reports, weak credit
management practice and poor credit quality are major factors of bank failures and banking crises.
Malaysia consider operational risk is important as credit risk.Match with emphasis in Basel 2 on
operational risk in banks and the collapse of several companies.
2- RISK MEASUREMENT CONT. Majority of the Islamic bankers prefer to
use traditional risk measurement. Minority of them use more technically
advanced risk measurement except for the internal-based rating system(46%) and estimates of worse case(43%).
The finding supported the argument in PROPOSITION 3.
3- RISK MANAGEMENT CONT. Islamic banks use similar methods of
risk management as the conventional banks.
Less usage of Shariah compliance techniques is due to the different interpretation by the Shariah scholars, and Salam and Istisna’a is not fully practiced by the banks.
Thus, PROPOSITION 4 is not been supported by the finding.
CONCLUSION Different contracts have different
implications for the importance of each risk
Each risk should be assessed separately to facilitate appropriate risk management.
Islamic banks perceived to use less technically advanced risk measurement techniques
Islamic banks are not fully using the Shari’a compliant risk mitigation method