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Islamic Banking And The Aspects Of Risk Management Finance Essay

Risk as obvious is uncertainty or exposure to any kind of uncertainty, Hence a risk in any financial institution can either be handled or avoided through mitigation system. Since 2007 when conventional banking crisis paved a way to global recession and financial crash of institutions, more need is felt to Monitor, Identify, Report, Measure, Manage and Control risks on the levels of financial institutions especially banks. Negligent and misconduct of risk management in banks can disrupt the smooth working of payment system and can lead to decreased scope for enterprise exposure to investment projects due to non reliance on financial institutions. The risk management is through, continuous and an integral working of banking sector. Usually banks are exposed to Equity investment risk ,Market risk ,Liquidity risk ,Rate of return risk ,Operational risk, Shariah Non Compliance Risk, Fiduciary risk etc

Objectives of Dissertation

The objective of the dissertation is to consider and understand the following in detail:

1. What is Islamic Banking system?

2. What are the aspects of Banking Risks?

3. Critical analysis of factors affecting the Risk Mitigation in relation to Islamic Banking?

4. Case study on how practical is Islamic Risk Mitigation system to mitigate the banking risks?

Learning Outcome

The object of the dissertation is to come up with an analysis and understanding of the concept and efficiency of Risk Management in Islamic Banking system.

Research Rational

“Banking is a shaky industry, and significant losses can crop up if risks are not well-managed or if risk measures turn out to be more rigorous than expected. The world of Islamic banking in particular, has been undergoing massive makeovers. The movement towards globalisation and new regulatory regimes has created new realities for the banking industry. Islamic banks do not only need to react to new realities, but also have to look critically into the risk inherent into their system. For example, lack of liquidity management instruments, poor financial reporting, substandard management systems and the needs to comply with Shariah as well as international regulatory requirements, introduce real challenge”. [1] 

Research Method

Deductive Research will be used during the dissertation to reach a specific observation. Deductive reasoning will works from the more general idea to the more specific conclusion if methods of risk mitigation are more effective in performance and their functions.

Research Approach

Qualitative or non-numerical data collection or explanation based research will be used. [2] As detailed data will be collected through the inspection of performance and risk element elvoved in different financial instruments working in the market. Through qualitative method investigation on why few islamic instruments carry more risk than other and how this risk is mitigated will be addressed.

Type of Data

Primary data will be used to gather the relevant organizational records and other material that has been collected through qualitative resources. Both these methods are important to be used because of their methodological effectiveness for the research.

Concept of Risk Management

“The business of Islamic banking is different (Obaidullah, M. 1998) [3] but an Islamic financial institution is exposed to all the risks that a conventional one is. Typical banking risk exposure includes the following:

• Financial: balance sheet, capital adequacy, credit, liquidity;

• Operational: fraud, product, business services, system failure, delivery, and process management;

• Business: country, reputational, regulatory, legal, macropolicy;

• Event: political, banking crisis, contagion (Daud Vicary Abdullah and Ramesh Pillai).” [4] 

Concept of Risk Management

“The business of Islamic banking is different (Obaidullah, M. 1998) [5] but an Islamic financial institution is exposed to all the risks that a conventional one is. Typical banking risk exposure includes the following:

• Financial: balance sheet, capital adequacy, credit, liquidity;

• Operational: fraud, product, business services, system failure, delivery, and process management;

• Business: country, reputational, regulatory, legal, macropolicy;

• Event: political, banking crisis, contagion (Daud Vicary Abdullah and Ramesh Pillai)”. [6] 

Literature Review

“The fiscal system, particularly commercial banks, constitutes a major link in the development of the economy. Only a secure fiscal system can give assurance and competent reallocation of resources thereby contributing to the long-term price constancy and the growth of domestic economy.” [7] “The financial crisis and global recession have provided many lessons in terms of risk mitigation strategy as well as stressed the need to develop assessment of systemic risk and macro prudential oversight (Rossi, V. and Rodrigo Aguilera, D. 2009)”. [8] “The speedy expansion in the volume and figure of Islamic banks seems to have led regulatory authorities to appreciate the need to expand suitable events that would authorise them to control their businesses, which vary from Western banks (Rifaat Ahmed Abdel Karim, 1996).” [9] “The Conventional banks with huge assets are starting banking ‘windows’. One will start operating a full Islamic banking subsidiary soon (Nassief, N. 1995).” [10] “The beginning of the millennium witnessed fast extension in Islamic finance products. Proficient bankers and Shariah specialists have been breathlessly racing to envisage new Islamic financial products that substitute every single interest-based contract that comes in the conventional market in a stepping up to fill in all gaps and assure every financing innovation or replacement. (KAHF, M. 2006).” [11] “ Explaining the same Siddiqi states an Islamic banking & finance association would neither pay interest nor earn interest. Bank-depositor relation on the basis of profit and lose and beneficial to the deposits pooled together. On the asset side a number of ways were tried to earn profits plus partnerships and profit-sharing (mudaraba) with businessmen (Siddiqi, N. 2000)”. [12] “The characters of Islamic financial instruments face same conventional risks joined with their instruments (Tahir, S. 2003)”. [13] 

“Kandasamy, A. (2007) signifies the fact that the augmentation in Islamic financing instruments is the key force to stipulate Islamic risk management tools” [14] . “Bakar (2007) articulates that principle of risk management is essentially acceptable as long they are free from taking and paying interest, uncertainty in pricing and any clause which disagree with the very purpose of an underlying contract” [15] . “There is a need to design and execute Islamic hedging and risk minimising facilities like Islamic futures and Islamic swaps. This will improve the profitability of Islamic banks while simultaneously reducing their risk exposure (Ebrahim, M.S. and Joo, T.K. 2001)” [16] . “There is no consecutive argument that risk management is very significant and essential part of the banking and financial sector. Smith, D. (2001) in his introductory comments, said “It is fair to say that this has not been an area where most Islamic Banks have excelled over the last 20 years. There have been major issues across the Arab world from Egypt to Kuwait, Qatar and Dubai over into Africa and eastwards into the subcontinent since Islamic Banking first became established Risks operating, credits, regulatory if we are honest with ourselves have frequently been ill understood and worse managed”. [17] 

“Events have demonstrated that countries can no longer afford banks ‘too big’ for national taxpayers to support in a crisis (Rossi, V. and Rodrigo Aguilera, D. 2009)”. [18] “Even though the presence of maxim “al-ghorm bil ghonm (no risk, no gain)” Islam finance establishes an argument against the edging of risk taking activities, i.e. risk avoidance” [19] , “and taking extreme risk like in maisir (gambling). Islamic banking and financial system endorse the operations of taking calculated risks, with the forecast to make gains.” [20] 

Conclusion

“This is the unique aspect of Islamic banking and finance. Hence, there is a sturdy case for insertion of investment accounts in capital and a need for substitute formulations of capital capability procedures for Islamic banks. Hence, Islamic financial institutions are considered to be quite robust”. [21] 

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