Risk Management in Islamic Finance


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Risk Management in Islamic Finance

  1. 1. Contents Managing Risk through Shari’a • Managing credit risk Compliant Solutions: Part I • Late settlement of obligations due to genuine financial difficulties • Repayments risks and unscrupulous defaulters • Payments safeguards with collateral • Case study examples • Liquidity risk • Reducing asset and liability mismatch Rodney Wilson • Controlling operational risk Professor • Adequacy of reporting systems Durham University • Foreign exchange risks • Permissible hedging instruments 24 July 2009 • Elimination of rate of return risk Presented by CFA Institute • Implications of prohibition of riba www.cfainstitute.org 2 Late Settlement of Obligations Due to Genuine Financial Difficulties Repayments Risks • Koranic teaching • Moral hazard problems • “If the debtor is in difficulty, grant him time till it is easy for • High degree of trust in Islamic finance, but him to repay. If ye remit by way of charity, that is best for this can be abused you if ye only knew” • Peer pressure can make borrowers p • Sura 2:280 acknowledge their responsibilities • Practical measures • Rescheduling but keeping same financing method and • Asymmetric information terms with no penalty to borrower • May make concealment of financial • Swap existing obligations for a qard hasan loan without position easy interest • Remission which may bring goodwill from other clients • Deterrent to mudaraba and musharaka financing 3 4 Unscrupulous Defaulters Payments Safeguards • “Cannot pay” compared with “will not pay” • Sequestration of assets • If no penalty for deliberate late payments then danger • Murabahah and ijara involve financing real assets that Islamic finance abused • Can be seized if default, but asset may not be • Possible non-financial penalties worth much to financier, as resale value limited • Blacklisting of defaulter • Seeking redress through the courts involving • P Personal fi l financing i imprisonment or confiscation of passport • Car and home purchase finance based on salary being directly paid into the bank making the • Financial penalty advance • Fine for late payments • Bank can impose limits on personal access to • Proceeds given to charity, as no gain permissible for salary until bank claims met financier 5 6 Hosted by CFA Institute www.cfainstitute.org
  2. 2. Collateral Case Study Examples • Qualifying assets • Real goods and commodities • Al Rajhi Bank • Suited for murabaha and ijara financing • Vehicle finance • Not permissible • Real estate finance • Accounts receivable • Financial assets such as bonds or other securities • National Commercial Bank • Hierarchy of capital suppliers • Murabaha Al-Ahli Islamic personal • Unsecured debt junior to secured debt finance • Notion of hierarchy of entitlement in event of default repugnant to most shariah scholars • Tayseer Al-Ahli cash finance • Investment partners all share losses as in mudaraba and musharaka 7 8 Al Rajhi Bank National Commercial Bank • Vehicle finance • Murabaha Al-Ahli Islamic personal finance • Net monthly income more than SR 3,000 • SR 20,000 to SR 1,500,000 • Employee for 2 years with approved employer • Repayments up to 7 years • Letter from employer required • Suitable for cars, electrical goods, building materials and • Aged over 20 furniture • Salary paid directly into bank • Bank makes all payments, and client repays bank payments • Housing finance • Tayseer Al-Ahli cash finance • As above plus details of property • Bank buys commodities and sells them to client for a markup • Property on plot of at least 250 square meters under tawarruq principle • Building should be completed with guaranteed 20 year • Client sells commodity back to bank for cash payment life • Client repays this plus the markup over 2-4 years on a • Property within development belt limits monthly basis 9 10 Hosted by CFA Institute www.cfainstitute.org