Risk management strategies and practices for Islamic banks

MUSCAT — Islamic Banking differs significantly from conventional banking approaches not solely by its nature, but also by way of the challenges it faces due to the complexity of its sophisticated nature, in the form of operational risks.

According to Basel II, “Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and system or from external events”.

However, according to the Islamic Financial Services Board (IFSB), in Islamic banks, operational risk is associated with the loss resulting from ‘inadequate, or failed internal processes, people, and system, or from external events, including losses resulting from Shariah noncompliance, and the failure in fiduciary responsibilities.

Thus the best way for Islamic banks to combat operational risks is to develop risk management strategies and practices said Arsalan Ahmed Qureshi, AVP — Senior Manager, Operational Risk — Risk Management Dept, Al Baraka Bank.

Keeping in line with this definition by the IFSB, simply put, the elements of operational risk exposures, related to Islamic banks are Shariah non compliance risk, fiduciary risk, people risk, technology risk, and legal risk.

According to IFSB guidelines, Shariah noncompliance risk arises from Islamic banks’ failure to comply with the Shariah rules and principles determined by its Shariah Board or the relevant body in the jurisdiction in which the Islamic bank operates resulting in the transaction being cancelled, and inability to recognise income or loss.

Fiduciary risk is the risk that arises from Islamic banks failure to perform in accordance with explicit and implicit standards applicable to their fiduciary responsibilities resulting in the deterioration of reputation. People risk is caused due to the lack of people who are adequately trained in modern financial transactions as well as Fiqh al Muamalat (Islamic law relating to financial transactions).

Technology risk occurs due to the Islamic banks’ inability to capitalise on the use of its technology in different ways.

Finally legal risk may arise from uncertainty in laws, the lack of a reliable legal system to enforce financial contracts, legal uncertainty in the interpretation of contracts, the legality of financial instruments, lack of availability of legal experts, and exposure to unanticipated changes in laws and regulations.

Operational risks are a recent addition to a list of risks faced by financial institutions which can lead to significant losses.

This sees various techniques being applied by these institutions, including Islamic banks, to measure and manage operational risks.

At Al Baraka Bank, Qureshi’s responsibilities are twofold, one as a strategic partner to the business units which involves advising them on risk/ regulatory issues and the best way to identify and manage operational issues.

The second is that of a risk controller setting parameters for risk activities. This makes him an expert on the subject of operational risks, risk strategies, measurement of operational risk capital, operational risk capital charge and tools and practices to combat operational risk — issues that will be highlighted in great detail at the Oman Islamic Banking and Finance Conference 2012.

(Oman Daily Observer / 23 May 2012)

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Alfalah Consulting - Kuala Lumpur:
www.alfalahconsulting.com
Islamic Investment Malaysia:
www.islamic-invest-malaysia.com