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INHERENT RISK: Credit and Market Risk. Author: Abdullah Haron and John Lee Hin Hock Presentation By: Mohd Khir Ashari. INHERENT RISK: MARRKET AND CREDIT RISK.
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INHERENT RISK: Credit and Market Risk Author: Abdullah Haron and John Lee Hin Hock Presentation By: MohdKhirAshari
INHERENT RISK: MARRKET AND CREDIT RISK • Institutions offering Islamic Financial Services [IIFS] are predicated on a different foundations from conventional financial institutions. • Over and above the general considerations of business ethics, IIFS profit seeking motive take second place to conformity with the principles and rules of the shariah as set out in Fiqh al Muamalat
INHERENT RISK: MARRKET AND CREDIT RISK • Financial institutions organized along the prohibition of interest-based product bear a resemblance to asset management companies and consequently, Islamic mode of finance display distinct risk character that must be accounted by CAR as well risk management framework.
INHERENT RISK: MARRKET AND CREDIT RISK Credit Risk: The possibility of the counterparties not fulfilling pre-determined obligations.
INHERENT RISK: MARRKET AND CREDIT RISK** Credit risk can be classified in the following way: • Credit Default Risk - The risk of loss when the bank considers that the obligor is unlikely to pay its credit obligations in full . Default risk may impact all credit-sensitive transactions, including loans, securities and derivatives. • Concentration Risk - The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank's core operations. • Country Risk - The risk of loss arising when a sovereign state freezes foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk).
INHERENT RISK: MARRKET AND CREDIT RISK Market Risk: The risk of losses in on- and off-balance sheet positions from variation in market prices. IIFS carry out many asset-based transactions in which they take ownership of the physical asset as co-investors. This setting expose them to market risk – as the asset price may fluctuate. Conventional FI are also exposed to this risk from the positions they held in financial instruments. The positions are held to secure short-term profit from price or interest rate variations or to hedge against other element in the trading books.
INHERENT RISK: MARRKET AND CREDIT RISK ASSOCIATED WITH THE FINANCING MODE • MURABAHAH • Credit Risk - customer may not honor payment obligations • Market Risk – customer cancel the purchase agreement and IFS is forced to sell the asset in the open market with price lower than the acquisition price. • SALAM • Credit Risk – customer may not honor payment when goods are not delivered/ or NOT delivered on time / or not according to specification / or the price may not covered the whole salam capital. • Market risk – immediately upon signing the agreement, the IIFS is exposed to price fluctuation. In salam with parallel salam, the IIFS is exposed to price risk when the supplier default on delivery (purchase in open market)
INHERENT RISK: MARRKET AND CREDIT RISK ASSOCIATED WITH THE FINANCING MODE • ISTISNA’ • Credit Risk - customer may not honor payment obligations – installments or progress billing. In istisna with parallel istisna, IIFS may not be able to recover advance payment to sub-contractor who does not complete work • Market Risk – customer defaul ton contract and IIFs has to find another purchaser thus it is exposed to price risk. Recovery may be a problem by itself. • OPERATING IJARAH • Credit Risk – customer may not be able to service the lease rental when it fall due. • Market risk – In non-binding lease agreement, when the customer opt not to fulfill its part, IIFS may have to lease the asset at a lease rental lower than the selling price. THE IIFS may also have to bear potential loss due to the fair value of the asset falling below the residual value as estimated.
INHERENT RISK: MARRKET AND CREDIT RISK ASSOCIATED WITH THE FINANCING MODE • Istisna’ • Credit Risk - customer may not honor payment obligations – installments or progress billing. In istisna with parallel istisna, IIFS may not be able to recover advance payment to sub-contractor who does not complete work • Market Risk – customer defaul ton contract and IIFs has to find another purchaser thus it is exposed to price risk. Recovery may be a problem by itself. • OPERATING IJARAH • Credit Risk – customer may not be able to service the lease rental when it fall due. • Market risk – In non-binding lease agreement, when the customer opt not to fulfill its part, IIFS may have to lease the asset at a lease rental lower than the selling price. THE IIFS may also have to bear potential loss due to the fair value of the asset falling below the residual value as estimated.
INHERENT RISK: MARRKET AND CREDIT RISK ASSOCIATED WITH THE FINANCING MODE • MUSHARAKAH • Credit Risk – IIFS may lose its entire invested capital as such capital rank lower than debt. IIFS may face risk due to withdrawal of partner who owes monies the IIFS. • MUDHARABAH • Credit Risk – IIFS may be exposed to capital ,losses if the venture suffer losses, or if the mudarib default on payment due to the rab-al mal.
INHERENT RISK: DISPLACED COMMERCIAL RISK • This risk is peculiar to IIFS • IIFS is compelled to increase the rate of return to IAH to persuade them to keep their fund in the institution. • Thus it is compelled to give up Some portion of its share of profit as a mudarib, - the rate of return to the client is ‘smoothed’ at the expense of profit normally attributable to the IIFS shareholders. • Although not obligated, due to commercial pressure, IIFS are virtually forced to do so.
UNIQUE DIMENSION TO RISK MANAGEMANT IN IIFS • The role of IIFS include as a financier, supplier, mudarib and musharakah partner. Thus IIFS are exposed to credit risk of non payment and may need to make or take delivery of a physical asset. • The assumption of credit risk varies according to the binding or non binding nature of the contract or on the transformation of investment account into debt in the case of proven negligence or misconduct of the mudarib. • The prohibition of imposing any penalty for delayed payment results in IIFS being unable to use conventional debt recovery techniques. This in turn enhance the use of guarantee and collateral as credit risk mitigants.
