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Risk Issues In Islamic Banking. International Islamic Finance Forum 1 7-19 March 2002 : Dusit Hotel, Dubai , UAE Warren Edwardes, ceo , Delphi Risk Management Limited e : we@dc3.co.uk w : www.dc3.co.uk. Delphi’s website contains :. articles on Islamic banking on : dc3.co.uk/ ibnews

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Risk issues in islamic banking
Risk Issues In Islamic Banking

  • International Islamic Finance Forum 17-19 March 2002 : Dusit Hotel, Dubai, UAE

  • Warren Edwardes,

  • ceo, Delphi Risk Management Limited

  • e: we@dc3.co.uk

  • w: www.dc3.co.uk

Warren Edwardes

Delphi s website contains
Delphi’s website contains:

  • articles on Islamic banking on:dc3.co.uk/ibnews

  • The full speech, on Risk Issues and Liquidity Management within Islamic Finance Institutes is on:dc3.co.uk/islamicfinancerisk020319.ppt

Warren Edwardes

Financial risk
financial risk

  • some actions can protect

  • the same actions can destroy

Warren Edwardes

From the book key financial instruments understanding and innovating in the world of derivatives
from the book:"Key Financial Instruments: understanding and innovating in the world of derivatives"

  • Appendix 1 (50 Risk types):

    • dc3.co.uk/risks.htm

  • Appendix 4 (Islamic banking)

    • dc3.co.uk/islamicbanking.htm

  • Does Islamic banking risk differ from Conventional banking risk?

    • Not different - just a special case

Warren Edwardes

A check list of 50 banking risk types
A check-list of 50 banking risk types

  • To put it simply and directly,

  • if the bosses do not or cannot understand both the risks and rewards in their products,

  • their firm should not be in the business. -

  • William J. McDonough, President, Federal Reserve Bank of New York

Warren Edwardes

Banking risk types 1 4
banking risk types - 1-4

  • Acquisition Risk

    • Different cultures between banks “consolidating”

  • Careless Error Risk

    • Human error should be forgiven. But this is not covered by law

  • Competitive Risk 

    • LIBOR / KLIBOR / EIBOR determine competitors returns

  • Commodity Risk

    • If you take delivery can the commodity price be managed?

Warren Edwardes

Banking risk types 5 8
banking risk types - 5-8

  • Communication Risk 

    • Al Wadiah or Musharaka ? Sudan case

    • Define terms clearly

  • Country Risk 

    • much of Islamic banking is carried out in emerging markets. Riskier?

  • Credit Risk

    • Not loans. Not IOUs. So equity not loan risk

  • Cultural Risk 

    • Difference between Gulf and Malaysia. Heard yesterday about the four schools in Fiqh Islam

Warren Edwardes

Banking risk types 9 12
banking risk types – 9-12

  • Currency Transaction Risk

    • No use of derivatives permitted. Cannot hedge exchange rate for purchases

  • Currency Translation Risk

    • Balance sheet value of dollar assets or liabilities fluctuate

  • Currency Economic Risk

    • Again no hedging permitted. So how can Proton compete with Hyundai cars if the KRW depreciates

  • Customer Satisfaction Risk

    • If a bank pays no dividends despite making profits customers will get angry

Warren Edwardes

Banking risk types 1 3 16
banking risk types - 13-16

  • Disaster Recovery Risk

    • If a terrorist or earthquake strikes can you cope?

  • Economic Activity Risk

    • Overheads are fixed. Post Sep 11 downturn is perhaps economic downturn and not money laundering related

  • Energy Price Risk 

    • Most Islamic countries’ economies are linked to the oil price

  • Environment Risk

    • Are environment unfriendly policies haram?

Warren Edwardes

Banking risk types 17 20
banking risk types - 17-20

  • Equity Market Risk 

    • Islamic banking is ideally profit and loss sharing. This is venture capital or equity investment

  • Fraud (banker) Risk

    • Transparency is required. Avoid the risk of misinterpretation

  • Fraud (customer) Risk

    • If an investor loses money will he seek redress? Of course if he wins he will not

  • Fraud (staff) Risk

    • Haram for lenders to seek material benefit. BCCI was not an Islamic bank but fraud could occur in Islamic banks

Warren Edwardes

Banking risk types 21 2 4
banking risk types - 21-24

  • Image / PR Risk 

    • Something deemed hallal could be deemed haram. Sep 11 was bad PR

  • Information Risk 

    • Lack of transparency in accounts in many Islamic countries

  • Inflation Risk 

    • The securitised asset increases in value but not the repayment amount which being a cash amount depreciates

  • Interest rate Risk 

    • This is not a closed economy. If interest rates rise sharply deposits will flow out

Warren Edwardes

Banking risk types 2 5 27
banking risk types - 25-27

  • Interaction Risk 

    • Same as correlation. Sep 11 had an effect

  • Language Risk 

    • Arabic, English, Malay, Indonesian, Urdu? Same word can have different meanings. Like Al Wadiah

  • Legal Risk 

    • UK, Malaysian, .. Is the bank / customer permitted to carry out such business. Ultra Vires issue

Warren Edwardes

Banking risk types 2 8 3 0
banking risk types - 28-30

  • Liquidity Risk 

    • Major problem for Islamic banking is the absence of a developed Islamic money market.

    • about managing confidence and the liability side.

    • About managing diversification.

  • Morbidity Risk

    • No different from conventional banking. What happens if there is an outbreak of dengue or Anthrax?

  • Mortality Risk 

    • Do you have offices in a tall building? Would you survive major loss through fire?

Warren Edwardes

Banking risk types 3 1 3 4
banking risk types - 31-34

  • Operational Risk

    • Are strong procedural systems in place? Really everything other than market risks

  • Performance Measurement Risk 

    • Most measures of performance are crude and slavish adherence to rules can lead to poor real performance

  • Political Risk 

    • Seizure of assets post Sep 11; boycotts

  • Competence / Understanding 

    • Are the latest products really understood by the banks’ senior management? By the customers?

Warren Edwardes

Banking risk types 3 5 38
banking risk types - 35-38

  • Concentration of assets Risk

    • A problem for Islamic funds. No tobacco, banking and alcohol stocks can lead to heavy weighting in property and technology

  • Concentration of liabilities Risk

    • Do you have enough investors or do you depend on one or two?

  • Concentration of business type Risk

    • Financial supermarket or nimble niche player are both fine. But can you reinvent yourself if markets change?

  • Convertibility Risk

    • Deliverability risk under exchange controls

Warren Edwardes

Banking risk types 39 4 2
banking risk types - 39-42

  • Property (Real Estate) Risk 

    • Would asset backing be sufficient in times of a property crash?

  • Rating Agency Risk 

    • A downgrading or even credit watch can impact on liquidity and the entire business. Investment grade bonds do not default. They become Junk and then default.

  • Regulatory Risk 

    • A firm operating globally will face different rules

  • Religious Risk 

    • A Hallal product may later be deemed Haram. Zero coupon bonds were Hallal

Warren Edwardes

Banking risk types 4 3 4 6
banking risk types - 43-46

  • Resignation Risk 

    • Over dependence on one person’s skills and contacts?

  • Settlement Risk 

    • If there is no escrow account there is settlement risk on Murabaha and BBA

  • Systemic Risk 

    • Financial instability is contagious. Financial systems are closely inter-linked

  • Tax Risk 

    • Do the sale and repurchase transactions face purchase tax? Income tax or capital gains tax treatment?

Warren Edwardes

Banking risk types 47 49
banking risk types – 47-49

  • Technological Risk 

    • Are your fax confirmations going to your customer or a competitor?

  • Transport Risk 

    • traffic jams may have led to cancelled meetings which may never be rearranged

  • Weather Risk 

    • Could you hedge against the weather? KL’s 1998 smog and Kuwait’s burning oil fields probably had an adverse impact on employees health.

    • Weather derivatives are being traded but probably Haram. Weather Takaful?

Warren Edwardes

Banking risk types 50
banking risk types – 50

  • Zero Risk

  • It’s impossible to take an unnecessary risk.

  • because you only find out whether a risk was unnecessary

  • after you’ve taken it

  • Giovanni Agnelli, President FIAT

Warren Edwardes

Particular islamic banking risk issues
Particular Islamic banking risk issues

  • Liquidity– undeveloped money market

  • Interest rate Risk 

  • Commodity

  • Equity risk – fund management or banking?

  • Operational risk

  • Religious – Hallal or Haram?

  • Language Risk - English, Arabic, Malay or Urdu

Warren Edwardes

Risk issues in islamic banking1
Risk Issues In Islamic Banking

  • International Islamic Finance Forum 17-19 March 2002 : Dusit Hotel, Dubai, UAE

  • Warren Edwardes,

  • ceo, Delphi Risk Management Limited

  • e: we@dc3.co.uk

  • w: www.dc3.co.uk

Warren Edwardes