Mapping the Risks and Risk Management Practices in Islamic Banking

Deep, insightful analysis of controversial risk management issues in Islamic banking

Mapping the Risks And Risk Management Practices In Islamic Banking is a comprehensive analysis of the current state of risk management practices within the Islamic banking industry, with recommendations for policy makers, bankers, and industry stakeholders. Going beyond the academic, this book presents the opinions and perceptions of industry financiers and bankers, alongside primary information and data collected by Islamic finance professionals to deconstruct and analyze the sector's current risk management practices. You'll get up to date on the latest attitudes and trends, and delve into the current issues surrounding risk management in Islamic banks. With a focus on practical applications, this authoritative guide discusses the unique risks facing Islamic banks, from the perspective of a wide range of practitioners.

Risk management is one of the biggest, most controversial issues in Islamic finance, yet it remains under-researched. Many uncertainties exist for which the answers are still unclear, yet will play a large role in shaping the industry's future. This book digs deep into current ideas and practices to discover what's being done, what needs to be done, and what needs to stop happening to keep the future of Islamic finance strong.

• Explore both Islamic and traditional attitudes toward risk
• Examine current Islamic risk management practices
• Understand the latest industry issues and trends
• Consider the diverse range of risks unique to the Islamic banking sector

Effective risk management in Islamic banking deserves priority attention. Unless the industry develops its own genuine risk management architecture, it cannot achieve its full potential and the viability needed for a more resilient financial system than the debunked Wall Street model. Mapping the Risks and Risk Management Practices in Islamic Banking provides a deep, authoritative analysis of where the industry is today and where it needs to develop.

Foreword xi

About the Authors xiii

Chapter 1 Introduction: Research Background and Motivation 1

Systemic Importance of Islamic Banking and Finance 3

Research Aims, Objectives and Questions 5

Research Hypotheses 6

Significance of the Study 7

Overview of the Research Methodology 9

Overview of the Research 10

Chapter 2 Principles of Islamic Banking and Finance 13

Historical Background of Islamic Banking and Finance 14

Size of the Industry 17

Principles of Islamic Banking and Finance 20

Basic Islamic Financing Contracts 20

Sukuk: A Step Toward Securitisation 25

Islamic Banking Versus Conventional Banking 31

Institutional Developments in Islamic Banking and Finance Industry 33

Conclusion 39

Chapter 3 Risk Management in Islamic Banks: A Theoretical Perspective 41

Risk Management: Basic Concepts and Techniques 44

Risk Management and the Credit Crunch 51

Classification of Risks 51

Risks Common to Both Islamic and Conventional Banks 54

Further Risk Areas Specific to Islamic Banks 93

Risk Categories are Entangled 106

Risk Management Issues in Sukuk 107

Risk Mitigation in Islamic Banking 110

Surveying Risk Management Practices in Islamic Banks: A Review of Empirical Research 120

Conclusion 123

Chapter 4 Capital Adequacy for Islamic Banks: A Survey 127

Significance of Capital in Banking 128

Classification of Capital 129

Steps in the Basel Accord 130

Basel II and Islamic Banks 138

Basel III 142

IFSB Principles on Capital Adequacy 143

Capital Adequacy as a Tool for Risk Mitigation 150

Conclusion 151

Chapter 5 Islamic Banking and the Financial Crisis 153

Understanding the Credit Crisis 156

The Financial Crisis and the Need for an Alternative System 163

The Financial Crisis and Islamic Finance and Banking as an Alternative Option 163

Deviations from the Foundational Shari’ah Principles: Evaluating the Operations of Islamic Finance 173

How to Achieve the Full Potential of Islamic Finance 177

Conclusion 181

Chapter 6 Research Framework and Methodology 183

Research Questions and Objectives 183

Research Hypotheses 185

Research Methodology 191

Research Design 191

Research Strategy 193

Research Method 194

Difficulties and Limitations 210

Conclusion 211

Chapter 7 Profiling Perspectives of Risk Dimensions in Islamic Finance: Descriptive Questionnaire Data Analysis 213

Data Analysis and Results 213

Conclusion 250

Chapter 8 Analysing Perceptions of Risk and Risk Management Dimensions and Issues: Inferential Statistical Analysis 253

Risk Perception 254

Risk Management and Reporting 295

Risk Measurement 301

Risk Mitigation 303

Islamic Banking in Practice 304

The Next Chapter in Islamic Banking 306

Conclusion 307

Chapter 9 Exploring Perceptions of Risk and Risk Management Practices in Islamic Banking: Interview Data Analysis 309

Interview Analysis 309

Forming the Main Interview Themes 310

Interview Questions 310

Results and Data Analysis 311

Conclusion 335

Chapter 10 Contextualising the Findings: An Interpretative Discussion 337

Risk Perception in Islamic Banking 337

Islamic Finance Contracts 345

Additional Risk Issues Facing Islamic Financial Institutions 351

Capital Adequacy for Islamic Banks 353

Islamic Banking and the Global Credit Crisis 356

Risk Management and Reporting 363

Risk Measurement 365

Risk Mitigation 367

Islamic Banking in Practice 370

The Future of Islamic Banking 372

Conclusion and Summary 378

Chapter 11 Conclusion and Research Recommendations 381

Summary of the Research 381

Reflecting on the Research Findings 382

Research Implications and Recommendations 386

Limitations of the Study 389

Suggestions for Future Research 390

Appendix 1: Questionnaire 393

List of Acronyms 401

Epilogue 403

Bibliography 405

Index 415

DR. WAEL KAMAL EID is the Chief Risk Officer at SEDCO Holding, the Chairman of the Board Audit and Risk Committee of Al Nahdi Medical Company and a Member of Auto World Audit Committee. He is a risk specialist in Islamic banking who holds an MBA with Distinction from Warwick Business School, and a PhD in risk management from Durham University. He has extensive experience in Risk Management and Islamic banking in the Middle East and Europe. He is also a guest lecturer on Risk Management and Islamic Finance at distinguished universities and speaks regularly at international Risk Management events and conferences. Dr. Eid is the winner of the 2015 Golden Peacock Award for Risk Management by the prestigious Institute of Directors (IoD).

DR. MEHMET ASUTAY is a Professor of Middle Eastern and Islamic Political Economy and Finance at the Durham University Business School; the Director of the Durham Centre in Islamic Economics and Finance; the Programme Director for MSc in Islamic Finance and MSc in Islamic Finance and Management programmes, and is also the Director of the Durham Islamic Finance Summer School. His teaching, research, publication, and supervision of research all falls within Islamic moral economy/Islamic economics, Islamic political economy, Islamic finance and banking, Islamic governance and management, and the Middle Eastern political economies. His articles on his research interest have been published in various international academic journals and professional magazines. Dr. Asutay has also published and edited books on aspects of Islamic moral economy and Islamic finance.

An insightful analysis of controversial risk management issues in Islamic banking

Islamic finance is the fastest growing sector in the financial industry. Solidly based in research, Mapping the Risks and Risk Management Practices in Islamic Banking offers a comprehensive and much-needed guide that explores the perceptions and attitudes of Islamic banking professionals towards contemporary risk management issues within Islamic banking. In addition to the expert opinions and information, this practical book contains recommendations for policymakers, bankers, and industry stakeholders.

Written by two experts on the topic (a well-known working professional and an acclaimed academic), the book effectively combines theory with practice and is filled with useful data and insight from industry financiers and bankers that help analyse the sector's current risk management practices. The authors review the recent trends and attitudes and explore the current issues that pertain to risk management in Islamic banks. The book also highlights the unique risks facing Islamic banks, from the perspective of a wide range of practitioners.

In recent years, the focus on Islamic banking has shifted away from interest-free banking to developing an Islamic financial industry that does not suffer from the weaknesses of the conventional banking system. This new focus highlights risk management and mitigation, financial engineering, innovation, and providing common standards in Islamic finance. The book digs deep into current ideas and practices to discover what's being done, what needs to be done, and what needs to stop happening to keep the future of Islamic finance strong.

The authors examine Islamic banking in light of the recent financial crisis, review the current Islamic risk management practices, and consider the range of risks that are unique to the Islamic banking sector. Mapping the Risks and Risk Management Practices in Islamic Banking provides a thoughtful, authoritative analysis of where the industry is today and where it needs to develop to meet the needs of the future.

Praise for Mapping the Risks and Risk Management Practices in Islamic Banking

"Mapping the Risks and Risk Management Practices in Islamic Banking offers a much-needed contribution to the literature on Islamic banking. The authors explore the basic tenets of Islamic finance and provide an overview of risks that are unique to Islamic banks. The book uniquely combines theory with practice; it contains the thoughts of Islamic banking professionals and explores the most recent developments and trends in the industry. This comprehensive and authoritative guide reviews the major findings, recommendations, limitations of Islamic banking and contains suggestions for future research."
—Adnan Ahmed Yusuf, President & Chief Executive, Al Baraka Banking Group

"The book serves as an essential guide to risk management in Islamic banking and is a 'must read' for researchers working in this area, including university faculty and postgraduate students of Islamic finance. Although primarily an academic study, the book should prove worthwhile reading for financial regulators and professional bankers working in the Islamic finance industry. The findings from the surveys are clearly explained and there is a useful chapter which provides an interpretative discussion. Overall the work is an insightful and useful piece of research."
—Prof. Rodney Wilson, Emeritus Professor, Durham University

"Mapping the Risks and Risk Management Practices in Islamic Banking is an excellent addition to literature. The authors have vast knowledge of the topic and have done extensive research in Risk Management in Islamic banking, which continues to be an under-researched area of study. This book not only provides an up-to-date overview of current market issues, trends and practices in risk management for Islamic banks, but also covers much ground by presenting discussions on a wide range of risks currently faced by Islamic banks. A highly recommended text to both practitioners and academics."
—Dr. Adnan Soufi, Commissioner, Capital Market Authority, KSA; former Dean of Faculty of Economics and Administration, King Abdulaziz University

"Well researched and clearly laid out, this book provides timely insight in the unique risks faced by Islamic financial institutions and how they can be managed. Recommended reading for anyone in risk management, or who may want to get a better understanding of the subject."
—Natalie Schoon, Principal Consultant, Formabb; Author of Modern Islamic Banking: Products and Processes in Practice