RISK MANAGEMENT IN ISLAMIC BANKS &

FINANCIAL INSTITUTIONS

WAEL EID
Chief Risk Officer & Member of the Investment Committee,
QInvest, Doha, Qatar

Dr Wael Eid is the Chief Risk Officer and member of the Investment Committee at
QInvest. He has extensive experience in Risk Management and Islamic banking in the
Middle East and Europe, with specific expertise in investment and credit risks, financial
analysis, and financial regulation.

Prior to his role at QInvest, Wael served as Chief Risk and Governance officer at SEDCO
Holding, where he chaired the Risk Management Committee, advising the CEO and Board
on various aspects of risk.

With over 20 years of experience in Risk Management, Wael has chaired several
committees, including the Audit and Risk Committee at Al Nahdi Medical Company during
its successful IPO, and was deeply involved in setting up the Risk function at the European
Islamic Investment Bank Plc. in London.

Wael holds an MBA with Distinction from Warwick Business School, and a PhD in Islamic
risk management from Durham University. He is the winner of the 2015 Golden Peacock
Award for Risk Management by the prestigious Institute of Directors (IoD) and is the joint
author of Mapping the Risks and Risk Management Practices in Islamic Banking published by
John Wiley & Sons.

Durham Islamic Finance Summer School 2023

Durham Islamic Finance Summer School
2023

RISK MANAGEMENT PRACTICES IN

ISLAMIC BANKS AND FINANCIAL
INSTITUTIONS

Wael Eid
Chief Risk Officer

Presented at the
Durham Islamic Finance Summer School 2023
Durham Centre for Islamic Economics and Finance
Durham University Business School, UK
31st July – 4th August 2023

Agenda
What is Risk Management?

Risk Management in Islam

Risk Management in Islamic Banking

Islamic Banking & the Financial Crisis

A practical Perspective: Perceptions of Banking Professionals

The Day After Tomorrow

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RISK MANAGEMENT IN ISLAMIC FINANCE

§ Text in Al-Quran
“O my children, do not enter the
capital of Egypt by one gate but go
into it by different gates. However,
know it well that I cannot ward off
you Allah’s will for none other than
He has nay authority whatsoever. In
Him I have put my trust and all who
want to rely upon anyone should put
their trust in Him alone.”
(Surah Yusuf: Verse 67)

§ Hadith from Prophet Muhammad s.a.w

Prophet (peace be upon him) once asked a Bedouin who had left his camel untied,
“Why do you not tie your camel?” The Bedouin answered, “I put my trust in God ” The
Prophet PBUH then said “tie up your camel first then put your trust in God.”

RISK KNOWS NO RELIGION…OR DOES IT?

§ “Risk knows no religion”, Michael Ainley, Head of Wholesale Banking, FSA

(2007)

§ Does risk management in Islamic banking differ from conventional banking?

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BANKING RISKS-ISLAMIC VS CONVENTIONAL

Interest

Conventional Profit and

banking Bank Counterparty
loss
Supplier of funds

Creditors

Risks
Defaults Profit + loss

Profit + loss

Islamic
banking Bank Profit and
loss
Counterparty
Investors Defaults
Profit + loss

• Risks in Islamic banking are more contract-centric than in conventional banking, where risks tend to be more product-centric.

• The Islamic financial model works on the basis of risk sharing

• This special relationships between the contracting parties in Islamic finance, which sometimes changes during the different stages of
the contract, has an impact on risk management.

WHAT ARE THE MAIN RISK FACING ISLAMIC BANKS?

§ What are the top risks facing IFIs?

§ Are Islamic banks more or less risky than their conventional peers?

§ Could the recent crisis have occurred under an Islamic banking system?

§ How developed and significant is hedging to Islamic banking?

§ Is there divergence between the current practice and moral principles of

Islamic banking?

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RISKS FACING ISLAMIC BANKS

What are the main risk facing Islamic banks?

Are Islamic banks more or Could the recent crisis How developed and Is there divergence between
less risky than their have occurred under an significant is hedging to the current practice & moral
conventional peers? Islamic banking system? Islamic banking? principles of Islamic bank?

What are the top risks facing IFIs?

Credit risk Market risk Capital risk Liquidity risk

Operational risk Fraud risk IT risk Key people risk

Regulatory risk Interest rate risk Legal risk Taxation risk

Strategic risk Residual risk Settlement risk Reputational risk

BANKING RISK EXPOSURES

Financial risks Operational risks Business risks Event risks

Balance sheet structure Internal fraud Macro policy Political

Income statement
structure and External fraud Financial infrastructure Contagion
profitability
Employment practices
Capital adequacy Legal infrastructure Banking crisis
and workplace safety
Clients, products and
Credit Legal liability Other exogenous risks
business services
Damage to physical
Liquidity Regulatory compliance
assets
Business disruption &
Reputational and
Market system failures
fiduciary
(technology risk)
Execution, delivery, and
Interest rate Country risks
process management

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ISLAMIC BANK RISK PROFILE I

People External events
Liquidity risk Market risk Sovereign risk
Security Processes

Systems
Operational risk Concentration risk
Generic

Investment risk Credit risk

Islamic
Legal risk Regulatory risk
Bank
Unique

Short track record Reputational risk

Corporate Displaced
governance risk commercial risk

Lack of Shariah non

Fiduciary risk
standardization risk compliance risk

ISLAMIC BANK RISK PROFILE II

Risk categories are entangled…

People External events

Liquidity risk Market risk Sovereign risk
Security Processes

Systems
Operational risk Concentration risk
Generic

Investment risk Credit risk

Islamic
Legal risk Regulatory risk
Bank
Unique

Short track record Reputational risk

Corporate Displaced
governance risk commercial risk

Lack of Shariah non

Fiduciary risk
standardization risk compliance risk

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FURTHER RISK MANAGEMENT ISSUES

Other risk management issues include:

Even the generic risks are more complicated for Islamic

banks

Risk categories are entangled

Risk management issues in Sukuk

Risk mitigation in Islamic banking

Capital Adequacy for Islamic Banks

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CREDIT AND INVESTMENT RISK FOR IFIs I

Credit & Investment Risks

Credit risk is generally defined as the risk of loss arising from default or failure to
perform. It is also referred to as ‘default risk’, which is one of the earliest recognized
risks in the financial industry. Traditionally, a large part of a bank’s profit came from
the lending businesses, and the majority of bank’s losses were also related to this
aspect of risk management; hence the focus was primarily on credit risk.

Unique characteristics of Credit & Investment Risks for IFIs

First access to Credit risk Risk issues in In bay’ al-salam Risk issues IFIs are IFIs have less
collateral but issues Mudaraba contracts, the under prohibited from sophisticated
foreclosure is in Murabaha investments IFI is exposed to Istisna’a charging credit risk
difficult additional risks contracts accrued interest management
practices

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CREDIT AND INVESTMENT RISK FOR IFIs II

IFSB Principles of Credit Risk Management

Principle 2.1 Principle 2.2

IIFS shall have in place a strategy for IIFS shall carry out a due diligence
financing, using various instruments review in respect of counterparties
in compliance with Shariah, whereby prior to deciding on the choice of an
it recognises the potential credit appropriate Islamic financing
exposures that may arise at different instrument
stages of financing agreements.

Principle 2.3 Principle 2.4

IIFS shall have in place appropriate IIFS shall have in place Shariah-
methodologies for measuring and compliant credit risk mitigating
reporting the credit risk exposures techniques appropriate for each
arising under each Islamic Islamic financing instrument
financing instrument.

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CASE STUDY AND STATISTICS

§ Ahmad Hamad Algosaibi & Brothers (USD 1bn)

§ The International Banking Corporation (TIBC) (USD 2.2bn)

§ Saad Group & Awal Bank (USD 5.5 bn)

§ Only 55 percent of GCC companies disclose the main executive positions of board
members, compared with 100 percent in Europe.

§ Only 32 percent of companies disclose other positions held by board members,

compared with 97 percent in Europe.

§ There is a need to improve transparency particularly there is little pressure to

change those opaque practices.

§ Name lending

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CONCENTRATION RISK FOR IFIs

Concentration risk for IFIs

Type of Asset Immaturity of Liability

concentration side securitization side

IFIs face high Limited scope of The relative Severe

concentration by eligible asset immaturity of concentration on
name and sector, classes for IFIs securitisation in the the liability side
as well as high increases industry means and limited
geographical concentration in that this financial funding sources
concentration investment technology has not
portfolios been widely used to
remove such excess
concentrations
from the balance
sheet of IFIs.

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MARKET RISK FOR IFIs

1. Market risk is generally defined as the risk of loss arising from changes in market prices and profit
rates, which will result in a change in earnings or fair value of a financial obligation resulting in a
capital gain or loss upon realization of the asset.

2. Market risk was recognized in the late eighties, after the increasing importance of stock markets, when
banks started investing heavily in securities.

3. Market risk is difficult to measure due to diversified portfolios, since it will consist of several markets,
currencies, indexes, and instruments. The larger the diversification of the portfolio, the more difficult
it is to accurately estimate market risks due to the correlation between risks.

4. There are several ways to measure and manage market risks, which vary among banks. Most banks
have limits and triggers for portfolios, individual transactions, sectors, and even for traders. Banks
also use marking to market, stop-loss provisions, gap analysis, back testing, and stress testing for their
daily risk management of banking and trading books. Stress testing is gaining more popularity to help
predict expected losses.

5. Factor sensitivities and VaR can be used for market-to-market trading. VaR is the most well-known
methodology to quantify and evaluate market risk in a systematic fashion. It is one of the newer risk
management tools that indicates how much a firm can lose or make with a certain probability in a
given time horizon.

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UNIQUE CHARACTERISTICS OF MARKET RISK FOR IFIs

Rate of
return risk
(profit rate
risk)
Commodity Equity
and price investment
risks risk
Characteristics
of market risk

Currency Mark-up
risk risk
Benchmark
risk

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IFSB PRINCIPLES OF MARKET RISK MANAGEMENT

IFSB Principles of Rate of Equity Investment Risk
Management

Principle 3.1 Principle 3.2 Principle 3.3

IIFS shall have in place appropriate IIFS shall ensure that their valuation IIFS shall define and establish the exit
strategies, risk management and reporting methodologies are appropriate and consistent, & strategies in respect of their equity
processes in respect of the risk characteristics shall assess the potential impacts of their investment activities, including extension and
of equity investments, including Muḍārabah methods on profit calculations and allocations. redemption conditions for Mudārabah and
and Mushārakah investments. The methods shall be mutually agreed between Mushārakah investments, subject to the
the IIFS & the Muḍārib & Mushārakah partners. approval of the institution’s Sharī`ah Board

IFSB Principle of Market IFSB Principles of Rate of Return

Risk Management Risk Management

Principle 4.1 Principle 6.1 Principle 6.2

IIFS shall have in place an appropriate IIFS shall establish a comprehensive risk IIFS shall have in place an appropriate
framework for market risk management management and reporting process to assess framework for managing displaced
(including reporting) in respect of all assets the potential impacts of market factors commercial risk, where applicable.
held, including those that do not have a ready affecting rates of return on assets in
market and/or are exposed to high price comparison with the expected rates of return
volatility for investment account holders (IAH).

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LIQUIDITY RISK FOR IFIs

Compensate for fluctuations Asset, liability matching Stress testing & stricter liquidity
Liquidity is necessary for banks to Liquidity risk results when the bank’s ability Inspired by international drive from the
compensate for expected and unexpected to match the maturity of assets and Basel Committee on Banking Supervision
balance sheet fluctuations and to provide liabilities is impaired. This risk may result (BCBS) & the Committee of European
funds for growth. from either difficulties in obtaining cash at Banking Supervisors on liquidity
reasonable cost from borrowings (funding management, regulators around the globe
risk) or sale of assets (asset liquidity risk). have been working on introducing a series of
new rules outlining features of new liquidity
regime which proposes much higher levels of
stress testing and stricter liquidity
management approaches. Basel 3 is the
most obvious example

Unique characteristics of Liquidity Risk for IFIs

Limited availability Shallow secondary Absence of lender of Wide maturity Certain characteristics
of Shariah- market last resort mismatches of some Islamic
compliant liquidity between assets & finance instruments
management liabilities: funding give rise to liquidity
instruments conundrum risks.

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IFIs BALANCE SHEET

Breakdown Analysis of Leading Islamic Banks’ Balance Sheets

Short term Medi um term Long term

IFIs are truly – and often more visibly – subject to the constant trade-off between
profitability and liquidity in a binary way

As sets Liabil ities

Sample of 20 leading Islamic Banks
Note: Asset/Liability tenure defined as follows: Short term – 0 to 3 months; Medium term -3+ months to 2 years;
Long term -2+ years and beyond
Source: Zawya
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CASE STUDY
Example of Imbalanced Funding Continuum
Imbalanced funding continuum heavily reliant on short-term customer
8,000,000 deposits to fund long-term assets

6,000,000
Short-term liabilities to fund
longer-term assets
4,000,000

2,000,000

-2,000,000
Negative liquidity gap in the
short-term
-4,000,000

-6,000,000
0-30 days 31-90 d ays 91-1 year 1-5 years 5 years +

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LIQUIDITY RISK

Early Warning Indicators :

1 2 3
4

Rapid asset growth Rapid asset growth Currency Decline in weighted

funded with potentially funded with potentially mismatches average maturity of
volatile liabilities volatile liabilities liabilities

5 6 3
4

Credit rating Rising wholesale or retail Negative Increasing retail

downgrade funding costs publicity deposit outflows

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CASE STUDY-NORTHERN ROCK

Northern Rock
§ Funding strategy mainly based on wholesale money and other capital market
funding

§ For years it was regarded as a star performer and the quality of its assets were
never questioned

§ Run on bank: £3bn of deposits were withdrawn

§ The Rock made a loss of £1.4bn in 2008

§ Bank of England had to step in as lender of last resort

§ The bank remained legally solvent

§ Having failed to find a commercial buyer for the business, it was taken into
public ownership in 2008, and was then bought by Virgin Money in 2012.

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ATTEMPTS TO REDUCE LIQUIDITY RISK FOR IFIs I

§ Saudi Arabian Monetary Agency (SAMA) has developed an ad-hoc
instrument called mutajara, which behaves like a repurchase agreement,
known as ‘repo’ in the banking world.

§ In Bahrain, the CBB is also working on developing a Shariah-compliant

repo scheme

§ LMC was founded in 2002 in Bahrain to facilitate the investment of

surplus funds of Islamic financial institutions into financial instruments
structured in accordance with Shariah principles. It also aims to assist the
IIFM in the creation of secondary market activity with designated market
makers where such instruments can be actively traded.

§ The IIFM has plans to co-operate with the International Capital Market
Association (ICMA) to develop a repo-type liquidity management tool in
order to manage overnight liquidity more efficiently in the future.

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ATTEMPTS TO REDUCE LIQUIDITY RISK FOR IFIs II

§ The Central Bank of Sudan has introduced Shariah-compatible securities
to provide liquidity in the market

§ Bank Negara Malaysia, introduced the Islamic Interbank Money Market

(IIMM) in early 1994. Whereas the contract of bay’ al-dayn is commonly
accepted and practiced in the Malaysian financial markets, it is not
accepted by the majority of Shariah scholars outside of Malaysia, who
maintain that debt can be traded only at par.

§ Sukuk can provide the foundation for the development of secondary

markets. A Sukuk structured on Murabaha, Salam, and Istisna’ should be
held to maturity, while Sukuk structured on an equity basis (Musharaka
and Mudaraba) or Ijarah Sukuk can be traded on the secondary market

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LIQUIDITY RISK MANAGEMENT

IFSB Principles of Liquidity Risk Management

1 2

Principle 5.1 Principle 5.2

IIFS shall have in place a IIFS shall assume liquidity risk

liquidity management commensurate with its ability
framework (including to have sufficient recourse to
reporting) taking into account Shariah-compliant funds to
separately and on an overall mitigate such risk.
basis their liquidity exposures
in respect of each category of
current accounts, unrestricted
and restricted investment
accounts.
IFSB-12: Guiding Principles on Liquidity Risk Management for Institutions offering Islamic
Financial Services – March 2012. Twenty three principles intended to serve Islamic banking
institutions.

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ASSET LIABILITY MANAGEMENT

§ Asset Liability Management (ALM) is closely correlated with liquidity risk management. It is simply the practice
of managing risks that arise due to mismatches between the assets and liabilities of a bank.
§ ALM in Islamic banking: theory vs. practice
§ ALM and Displaced Commercial Risk
§ Managing displaced commercial risk efficiently is a dynamic exercise

Provisions from income PSIA capital & PER + Capital & IRR Takaful
Frequency of losses

High
frequency

Unexpected losses from PSIA financial assets Highly unlikely yet

Unexpected losses from current account & capital high severity of losses
Expected loss financed assets

Size of losses

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SOURCES OF FUNDS
Islamic vs. Traditional Banks

Islamic Banks Traditional banks

Tier – 1 capital (equity) Tier – 1 capital (equity)
Tier – 2 capital Tier – 2 capital (Subordinated loans)
Current accounts Current accounts
Saving accounts Interest-based saving accounts
Unrestricted profit sharing investment Time & certificate deposits
accounts
Profit equalization reserves (PER) Reserves
Investment risk reserve (IRR)

Islamic Banks Traditional banks

Current accounts Current accounts
Banks in both cases use the shareholders’ equity to protect these deposits
Time deposits certificates of deposits etc
Profit sharing investment account (PSIA)
– fixed income liabilities
Shareholders equity protects these
Shareholder’s equity and subordinated
liabilities only in case of fiduciary risks
loans protect these liabilities against all
(theory); Profit equalization reserve
risks
(PER) & Investment risk reserve (IRR)
Cost of funds: Variable Cost of funds: Fixed

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DISPLACED COMMERCIAL RISK

§ This risk is the transfer of the risk associated with deposits to equity holders.
§ This arises when banks under commercial pressure forgo a part of profit to
pay the depositors to prevent withdrawals due to a lower return
§ Displaced commercial risk implies that the bank, though may operate in full
compliance with the Shariah requirements, yet may not be able to pay
competitive rates of return as compared to its peers
§ Depositors will again have the incentive to seek withdrawal.
§ To prevent withdrawal, the owners of the bank will need to apportion part of
their own share in profits to the investment depositors.

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OPERATIONAL RISK
§ Historically, operational risk has been defined as all risks other than market, credit, and liquidity
risk. However, the BCBS has narrowed this definition within Basel II by stating that operational risk
is “The risk of loss resulting from inadequate or failed internal processes, people or systems or
from external events.” This definition includes legal risk, but excludes strategic and reputational
risk.
§ Operational risks are rather difficult to measure and manage because these risks only become
apparent once a problem arises. Risks associated with operational risk could include:
i. Internal fraud
ii. External fraud
iii. Employment practices and workplace safety
iv. Clients, products and business practices
v. Damage to physical assets
vi. Business disruption and system failures
vii. Execution, delivery and process management
§ Banks often use internal audit ratings, quality self-assessments, operation risk indicators or Key
Risk Indicators (KRIs) such as volume, turnover, or rate of errors, income and loss volatilities, etc.

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UNIQUE CHARACTERISTICS OF OPERATIONAL RISK FOR IFIs

§ Cancellation risks in the nonbinding contracts;

§ Failure of the internal control system to detect and manage potential problems in the
operational process and back-office;

§ Potential difficulties in enforcing Islamic contracts in a broader legal environment;

§ Need to maintain and manage commodity inventories often in illiquid markets;

§ The monitoring of PLS arrangements cannot easily be standardised;

§ Documentation risk is higher for Islamic banks than for conventional bank‘s partly as a
result of the lack of standardisation in the contracts and also because any deficiencies
in the documentation could make the contract unenforceable

§ Potential costs and risk of monitoring equity-type contracts and the associated legal
risk;

§ People’s risk and the scarcity of qualified human resources ; and

§ Technology risk
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CASE STUDY I
(1) Barings Bank
§ In February 1995, Nick Leeson, a rogue trader from Barings Bank, UK, single-handed caused the
financial collapse of a bank that had been in existence for hundreds of years.

§ Barings had been the United Kingdom's oldest investment bank; it had financed the Louisiana
Purchase between the US and France in 1803, and it was Queen Elizabeth’ s favorite bank.

§ Leeson was dealing in risky financial derivatives in the Singapore office of Barings and was betting
heavily on options for both the Singapore and Nikkei exchange indexes.

§ There was no direct oversight of his book and he even set up a dummy account to funnel losing
trades.

§ In January 1995, a huge earthquake hit Japan, sending financial markets reeling, which adversely
affected Leeson’s position.

§ By late February, he faxed a letter of resignation and when his position was discovered, he had lost
USD 1.4 bn.

§ Barings became insolvent and was sold to a competing bank for USD 1.00!

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CASE STUDY I
(1) Barings Bank
Discussion Questions: Group Exercise

§ How was it that Mr. Leeson was able to hide account number 88888 from the
rest of Barings Bank?

§ Was Mr. Leeson really responsible for the collapse of Barings Bank?

§ What are the lessons learnt from the collapse of Barings Bank?

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CASE STUDY I
(1) Barings Bank

1
Management failed to institute proper control
systems
2
Lack of adequate segregations between various
functions
3 Systems of check and balances failed at number of
levels
4
Dubious practices designed to conceal losses

5
Quick profits and greed controlled the game
overriding ethical foundations
6
Failure to implement auditor’s recommendations

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IFSB PRINCIPLES OF OPERATIONAL RISK MANAGEMENT

IFSB Principles of Operational Risk Management

1 2

Principle 7.1 Principle 7.2

IIFS shall have in place appropriate

IIFS shall have in place adequate
mechanisms to safeguard the
systems and controls, including
interests of all fund providers.
Shariah Board/ Advisor, to ensure
Where IAH funds are commingled
compliance with Shariah rules and
with the IIFS’s own funds, the IIFS
principles.
shall ensure that the bases for
asset, revenue, expense and profit
allocations are established, applied
and reported in a manner consistent
with the IIFS’s fiduciary
responsibilities.

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SHARIAH AND FIDUCIARY RISK

Shariah Non-Compliance Risk

Shariah arbitrage Lack of standardization risk Non-compliance Shortfall of

risk risk scholars
Example: The curious case of Investment
Dar Company (‘TID’) vs. BLOM
Development Bank

“Since Shariah non-compliance is the highest risk facing IFIs, a separate session is dedicated to practical steps for regulatory supervision of IFIs.

Fiduciary Risk

A lower rate of return than the Fiduciary risk can be caused by Fiduciary risk can be caused by While, the justification for the
market rate also introduces breach of contract by the Islamic breach of contract by the Islamic Islamic banks’ business is in
fiduciary risk, when bank. bank. compliance with Shariah, an
depositors/investors interpret a inability to do so or not doing so
low rate of return as breaching willfully can cause a serious
of investment contract or confidence problem.
mismanagement of funds by the
bank (AAOIFI 1999).

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LEGAL AND OTHER RISKS

Legal Risk

Given the different nature of As there are no standard form of Lack of standardized contracts along
financial contracts, Islamic contracts for various financial with the fact that there are no
banks face risks related to instruments, Islamic banks prepare litigations systems to resolve problems
their documentation and these according to their associated with enforceability of
enforcement. understanding of the Shariah, the contracts by the counterparty increase
local laws, and their needs and the legal risks associated with the
concerns. Islamic contractual agreements

Other Risks facing IFIs

Reputational Risk: Accounting Regulatory & Risk categories are Corporate Governance Risk management Short Track
in 2006, there was US state enforcement Standards Tax Issues entangled. Risk issues in sukuk Record
action against Doha Bank’s Islam ic Conglomeration of Case studies :
banking arm in its New York branch
risks: each mode of 1- Ahmad Hamad Algosaibi
relating to insufficient anti-money
laundering controls and systems. In April finance carries various 2- Saad Group
2009, Doha Bank paid a fine of USD 5 risks bundled together
million, which was imposed by two US
governm ent agencies: the Financial
Crimes Enforcement Network and the
Office of the Comptroller of the
Currency.

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PRACTICAL DEFAULT CASE OF SUKUK

East Cameron Asset-Backed Sukuk: Who owns the assets?

The East Cameron Partners L.P. (ECP) sukuk was relatively small one at USD 165.67 million
and was issued in July 2006. It was the first issued by a US company and was a genuine
effort at an asset-backed Musharaka. It was secured by an interest in the oil and gas royalty
rights on two gas fields in the Gulf of Mexico. On 16 October 2008, East Cameron Partners
(the originating company), filed for Chapter 11 / bankruptcy in the US courts.
A sukuk enforcement event was then triggered on 3 September 2008 due to a shortfall in
the stressed oil and gas reserves. With an asset-backed structure sukuk investors already
have legal rights over the oil and gas assets but ECP requested a ruling that the transaction
was not a ‘true sale’ but a ‘secured loan’. In the former, sukuk investors have sole rights to
the assets in the latter they would lose their rights and share the assets with the other
creditors should ECP enter Chapter 7 (liquidation).
Ultimately providing asset security for investors is a legal issue that impacts conventional
and sukuk structures equally. The concept is well tested in the US so investors’ rights should
be preserved if structured correctly. In the Middle East, legal systems are less tested and
secured sukuk are the minority. Investors in asset-based sukuk have no senior claim or lien
over the sukuk assets – but this is deliberate and clear to most parties.

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RISK MITIGATION IN ISLAMIC BANKING

§ Shariah and Islamic Derivatives

§ Islamic Hedging Tools

Ø Bai’ salam
Ø Arbun
Ø Khiyar al-shart
Ø Wa’ad
Ø Dual Murabaha

§ Further Risk Mitigation Provisions Inherent in Islamic Banking

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RISK MANAGEMENT IN ISLAMIC BANKS: A

PRACTICAL PERSPECTIVE
§ Theory is, unfortunately, a long way from fact in its current financial practice

§ Islamic banks reluctant to apply PLS technique in the case of losses fearing a
much higher risk of a Rush, leading to loss of liquidity, reputation, and
business, rendering its continuity questionable

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RISK AND THE CITY...

§ Innovation driven - Creation of complex and opaque financial instruments

Ø Hedging (risk transfer)
Ø Speculation
§ Over reliance on capital markets and securitization
§ The above broke down old relationships, and created a web of new ones
§ Created new risks that were not well understood
§ Focus on capital with liquidity largely forgotten

The rotten heart of finance: The root of all financial crises is a similar fault – greed and
lack of morality.

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THE DAY AFTER TOMORROW

§ Mind the Gap - the liquidity gap
§ Innovate, do not imitate
§ Consolidation
§ Diversification... as concentration kills
§ Investing in risk management infrastructure
§ Back to roots: Shariah based approach vs Shariah compliance

When the short-terms risks and the longer-term stability are put together and optimised,
the outlook for the Islamic banking industry looks less risky than its critics claim.

Innovation & Shariah-based industry is the new vision

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Wael Eid-Risk Management Practices in Islamic Banks and Financial Institutions

Durham Islamic Finance Summer School
2023

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Wael Eid
Chief Risk Officer
[email protected]

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Wael Eid-Risk Management Practices in Islamic Banks and Financial Institutions