Risk Management for Islamic BanksRecent Developments from Asia and the Middle East
Wiley Finance 1. Aufl.
Gain insight into the unique risk management challenges within the Islamic banking system Risk Management for Islamic Banks: Recent Developments from Asia and the Middle East analyzes risk management strategies in Islamic banking, presented from the perspectives of different banking institutions. Using comprehensive global case studies, the book details the risks involving various banking institutions in Indonesia, Malaysia, UAE, Bahrain, Pakistan, and Saudi Arabia, pointing out the different management strategies that arise as a result of Islamic banking practices. Readers gain insight into risk management as a comprehensive system, and a process of interlinked continuous cycles that integrate into every business activity within Islamic banks. The unique processes inherent in Islamic banking bring about complex risks not experienced by traditional banks. From Shariah compliance, to equity participation contracts, to complicated sale contracts, Islamic banks face unique market risks. Risk Management for Islamic Banks covers the creation of an appropriate risk management environment, as well as a stage-based implementation strategy that includes risk identification, measurement, mitigation, monitoring, controlling, and reporting. The book begins with a discussion of the philosophy of risk management, then delves deeper into the issue with topics like: Risk management as an integrated system The history, framework, and process of risk management in Islamic banking Financing, operational, investment, and market risk Shariah compliance and associated risk The book also discusses the future potential and challenges of Islamic banking, and outlines the risk management pathway. As an examination of the wisdom, knowledge, and ideal practice of Islamic banking, Risk Management for Islamic Banks contains valuable insights for those active in the Islamic market.
Preface xv Acknowledgments xxi About the Authors xxiii List of Acronyms xxv PART ONE Introduction CHAPTER 1 Principles of the Islamic Financial System 3 Islamic Financial Contracts: The li-tabarru’ Contract versus li-tijari Contract 3 Principles of Islamic Finance 5 Interest-Based Return versus Profit–Loss Sharing 6 CHAPTER 2 The Islamic Bank and Risk Management 9 Differences between an Islamic Bank and a Conventional Bank 10 History of the Islamic Bank 11 Global Islamic Banking Entities 12 Risk as an Integral Part of Islamic Bank 16 Stages in Risk Management 20 Risk and Return Trade-Off 27 Various Approaches on Risk Identification 28 The Importance of Risk Management for an Islamic Bank 28 PART TWO Risk Management Framework in Islamic Banking CHAPTER 3 History of Risk Management in Islamic Banking 33 Basel I and Its History 34 Basel II and Its History 36 Basel III and Its History 40 The AAOIFI and Its Role 43 The IFSB and Its Role 44 CHAPTER 4 The Risk Management Process in Islamic Banking 47 Risk Management Model in Islamic Banks 47 Risk Identification Process in Islamic Banking 56 Risk Matrix 57 Risk Mitigation Process 61 Risk Review Process 62 Infrastructure and Facilities 62 Calculation of Minimum Capital Requirements 66 CHAPTER 5 Financial Reporting and Analysis in Islamic Banking 72 The Importance of Financial Statements in Risk Analysis 72 Scope of Financial Statement in Islamic Banks 74 Basic Contracts and Instruments in the Islamic Bank 78 Structure of the Balance Sheet 80 Analysis of Income Statement 87 Persistence Analysis 88 Tools of Financial Statement Analysis 89 Core Business Activity in Islamic Banks 92 Off-Balance Sheet Activity in Islamic Banks 101 PART THREE Risk Management in Islamic Banking CHAPTER 6 Financing Risk in Islamic Banking 107 Urgency of Financing Risk Management in Islamic Banking 107 Characteristics of Islamic Financing Contracts 108 Financing Risk: Definitions and Its Scope 110 Role of Rahn and Kafalah 112 Defining Determinant Factors of Financing Risk 114 Urgency of the Independent Rating Agency 128 Rating and Financing Risk Provisions 130 Risk-Based Financing Limit 133 Concentration Risk in Financing Portfolio 133 Financing Portfolio Management 135 Measuring Financing Risk in the Islamic Bank 139 CHAPTER 7 Operational Risk in Islamic Banking 144 Urgency of Risk Awareness 144 Operational Risk Coverage in Islamic Banks 145 Identification of Operational Risk Factors 149 Operational Risk in Islamic Financial Contracts 155 Measurement of Islamic Operational Risk 160 Developing an Operational Risk Management System 166 CHAPTER 8 Syari’ah Compliance Risk 168 Basic Principles of Islamic Economics and Financial System 169 Syari’ah as Principle and Spirit in Business 170 Various Prohibitions in Mu’amalah 172 Why Should Islamic Banking Comply with Islamic Principles? 175 Integrating Syari’ah Compliance in the Islamic Bank 176 Evolution of Syari’ah Governance in Islamic Financial System 177 Syari’ah Advisory Board and Syari’ah Compliance Audit as a Framework 179 Identification Process of Syari’ah Compliance Risk 183 Risk Management and Mitigation of Syari’ah Compliance Risk 187 Models of Syari’ah Governance in Several Countries 188 CHAPTER 9 Strategic Risk 194 Definition and Scope of Strategic Risk in Islamic Banking 195 Determinants of Strategic Risk and Its Mitigation 196 Issues Related to Strategic Risk 204 CHAPTER 10 Investment Risk in Islamic Banking 209 Syirkah as a Distinct Trait of Islamic Banks 209 Basic Concept of Investment Risk 210 Forms of Risk and Their Mitigation 216 Regulations on Profit Distribution Management 230 CHAPTER 11 Market Risk in Islamic Banking 232 Urgency of Market Risk 233 Scope of Market Risk in Islamic Banks 234 Identification of Market Risk Profile 239 Market Risk Measurement in Islamic Banks 244 Market Risk Mitigations in Islamic Banking 253 Implementation of Market Risk Mitigation 256 CHAPTER 12 Liquidity Risk in Islamic Banking 264 Urgency of Liquidity Risk 264 Credit Multiplier, Financial Stability and Liquidity Crises 265 Definition and Coverage of Liquidity Risk 267 Islamic Bank’s Assets and Liabilities 271 Liquidity Risk Management in Islamic Banks 272 PART FOUR Future Prospects and Challenges in Islamic Banking CHAPTER 13 Development of the Islamic Financial Market 285 Islamic Capital Market 286 Derivative Islamic Market 292 Regulation and Supervisory in Islamic Financial Market 294 Institutional-Based Development Framework 295 Stability in Islamic Financial System: Lesson from Global Financial Risk 296 CHAPTER 14 Development of a Pricing Model in Islamic Banking 299 Fundamentals in Islamic Pricing Model 299 Time Value of Money in Pricing Model 302 Current Islamic Pricing Model 305 Urgency of Pricing Mechanism in Islamic Banks 314 CHAPTER 15 Pathways of Risk Management in Islamic Banks 315 Islamic Banks as Real Implementation of Risk Management 315 Challenges of Islamic Banking in the World 317 Blueprint for Islamic Banking Regulation 319 Prospects and Challenges of Islamic Banking Development 323 Strategic Issues in the Implementation of Islamic Risk Management 324 CHAPTER 16 Future Agenda 328 Landscape of Integrated Islamic Risk Management 329 Synergy and Integration among Islamic Financial Institutions 330 Competency and Competitiveness of Islamic Banking 331 Regulatory Agenda in the Future 333 Anticipating the Potential Systemic Risks 335 PART FIVE Conclusion CHAPTER 17 Summary and Conclusion 345 Glossary 350 Bibliography 359 Index 383
IMAM WAHYUDI is a lecturer in the Faculty of Economics and Business at University of Indonesia (FEB-UI) and a senior researcher at the Centre of Islamic Economics and Business. FENNY ROSMANITA is a lecturer at FEB-UI and a researcher at its Centre of Islamic Economics and Business. MUHAMMAD BUDI PRASETYO is a lecturer and junior researcher in the Department of Management at FEB-UI. NIKEN IWANI SURYA PUTRI is a lecturer at FEB-UI and a junior researcher at its Centre of Islamic Economics and Business.
Volumes have been written on managing risk in today's strictly regulated and complex global financial system, but Risk Management for Islamic Banks uniquely examines how state-of-the-art risk management strategies and practices can be applied to the nuanced practices and philosophies behind the Islamic banking system. While Islamic banks are mostly immune to risks conventional banks face due to religious law forbidding the institutions from usury, this same syari'ah law restricts banks from accessing hedging products conventional banks use to mitigate risk. This convenient guide is logically written with an easy-to-understand yet useful depth of coverage to provide a single-source reference for understanding and navigating the Islamic banking sys-tem. Insightful explanations clarify the bank's place in Islamic finance, the Islamic perspective on risk, the risk management framework in Islamic banking, the distinct risks faced by Islamic banks, and syari'ah-compliance risk. Through comprehensive case studies of banks in Indonesia, Malaysia, UAE, Bahrain, Pakistan, and Saudi Arabia, you see firsthand: The benefits Islamic banks gain from practicing good risk management The structure of an Islamic bank's financial statement and the latest tools for analyzing it Islamic bank accounting standards as they relate to various measurements, methods, and risk models The importance of risk and rate-of-return to Islamic banks The reasoning behind amendments and revisions to Basel I, II, and III Specific regulations issued by Bank Indonesia The role of rahn (asset collateral), kafalah (third-party guarantee), and other factors determining financing risk The pros, cons, and challenges of creating syari'ah-compliant products Written by an authoritative team of authors from one of the top research universities in Asia, this progressive guide looks into the future to discuss the need for Islamic banks to develop a pricing system independent of a usurious refer-ence rate, which may involve the microeconomics of banking approach, the real sector's rate-of-return, and the productivity-based pricing model, among other factors. The path to mastering the Islamic banking system starts with Risk Management for Islamic Banks.
Praise for Risk Management for Islamic Banks "I must congratulate the authors on this important piece of work which fills a critical gap in the literature. There are not that many books on the topic of risk management of Islamic banks and this volume is certainly one of the best ones on the topic. Risk management is not an easy topic to handle but this volume presents complex concepts and issues in a clear manner to enhance the understanding of the reader. This volume should be looked at seriously by every student and researcher of the topic. The authors should be commended for this service." —Zamir Iqbal, Lead Financial Sector Specialist, World Bank Global Islamic Finance Development Center, Istanbul "With the increase in size of Islamic financial institutions and complexity of Islamic financial products and transactions, a greater need for comprehensive regulation and effective risk management is felt in the countries where Islamic banking and finance exist. This book is an excellent contribution to Islamic financial risk management, and will help teachers and trainers in the field to expose learners to a wide range of topics on the subject. While treatment of generic risk is consistent with the mainstream literature on risk management, it is the exposition of the unique risks facing Islamic banking and finance which makes the book a valuable resource for those who are looking to understand the regulatory and risk considerations of Islamic financial institutions. I expect this book to become an integral component in the curricula of undergraduate studies in Islamic banking and finance. The teaching staff at the universities offering postgraduate modules on Islamic banking and finance may also find the book of great relevance to the needs of their students." —Humayon Dar, (Cantab), Globally Renowned Expert of Islamic Banking and Finance; Founder, Islamic Bankers Association "Although modern Islamic banking started 40 years ago, publications on risk management for Islamic banks are relatively limited. The efforts by four budding scholars to write on this topic are indeed laudable. This book discusses risk management for Islamic banks in a comprehensive manner and yet makes it easy for readers to understand. Practitioners, researchers, academics, and students will find it useful as it provides conceptual understanding as well as examines contemporary risk management practice in Islamic banks." —Azmi Omar, Director General, Islamic Research and Training Institute - Islamic Development Bank Group
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