Professional Documents
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Islamic Risk Management1
Islamic Risk Management1
ZULKIFLI HASAN
HAWKAMAH, THE INSTITUTE OF CORPORATE GOVERNANCE
26TH MARCH 2009
CONTENTS
Introduction
Case Study: Closure of Ihlas Finance, due to Poor
Corporate governance (CG)
What is CG?
Why it is important to Islamic risk management
system?
Elements of Good CG in IFIs
Risk Management in IFIs
Roles of Board of Directors (BOD) and Senior
Management
Roles of Shari’ah Board
Concluding Remarks
Financial Distress and Failure of Ihlas Finans
Control
Failures
Management
Failures
Indulge in fraudulent
Allowing Withdrawal from practices, some of the
Investment Accounts, mudharabah agency financing
was done in the name of
Failure to manage liquidity fictitious parties while the
risk funds were used for solving
internal financial problems
Drastic application
Lax Supervision
of rules
Regulatory
Failures
Unclear scope of
Lacuna in deposit protection
supervision of law law and confusion on
who is the authority
What is CG?
CG is the system by which business corporations are
directed and controlled .
CG specifies the distribution of rights and
responsibilities among different participants in the
company such as BOD, Shari’ah board, managers,
shareholders, and other stakeholders.
A concept of CG in IFIs presents distinct
characteristics and features in comparison with the
conventional system as it goes beyond the financial
return whereby it covers the element of ethic,
Shari’ah and beliefs (aqidah).
Shari’ah board plays significant role to supervise ,
oversea and advise the shari’ah aspects of the
corporation.
Why CG is important for risk management in
IFIs?
Hypothesis 1: Weak CG may lead to
ineffective risk management system.
Hypothesis 2: Strong commitment to good
CG will improve and strengthen risk
management system in IFIs
Case Study: Ihlas Finans was closed in 2001
due to poor CG while the other five Islamic
banks in Turkey were survived because of
better CG.
Existing Studies
Well governed UK companies posted 18% higher returns
than those with poor governance after adjusting for risk
(ABI Research Paper 7: 2008);
Well governed firms in Korea have been found to trade at a
premium of 160% to poorly governed firms (Black, B Et al:
2004);
A study of S&P 500 firms showed that companies with
strong or improving CG practices outperformed those with
poor or deteriorating governance practices by about 19%
over a 2-year period (Grandmont, R Et al: 2004).
A worst-to-best improvement in CG predicted an
astronomical 700-fold increase in firm value among Russian
firms (Black, B: 2001).
The Six Elements of Good CG in IFIs
Good Board
Practice
Sound Shari’ah
Disclosure and
Governance
Transparency
system
Control
Commitment to
Environment and
Good CG
Processes
Shareholders Right
Risk Management in IFIs
Certain types of risks are of equal concern to all
financial institutions, including IFIs.
IFIs face additional risks that emanate from the
unique characteristics of Islamic finance
transactions, along with risks associated with the
real or perceived non-compliance of Shariah
principles.
The survival and success of IFIs depends on the
efficiency in which they can manage its risks and
how they will manage different risks arising
from their operations.
How good CG may improve Risk Management
System?
IFIs shall have in place a comprehensive risk
management and reporting process, including
appropriate board and senior management oversight,
to identify, measure, monitor, report and control
relevant categories of risks and, where appropriate,
to hold adequate capital against these risks.
The process shall take into account appropriate steps
to comply with Sharī`ah rules and principles and to
ensure the adequacy of relevant risk reporting to the
supervisory authority.
Risk Management in IFIs
• Credit Risk
• Equity Investment Risk
Board and • Market Risk
Senior • Liquidity Risk
Management • Rate of Return Risk
• Operational Risk
• Shari’ah Non-compliance
Shari’ah Board Risk
Roles of Board and Senior Management
Credit Risk •Strategy for financing and recognize the potential credit exposures.
•Carry out due diligence review
•Appropriate methodologies for measuring and reporting credit risk
exposure
•Shariah-compliant credit risk mitigating techniques
Equity •Strategy for risk characteristics of equity investments
Investment Risk •Appropriate valuation methodologies
•Establish exit strategies in respect of equity investment activities
Market Risk •Appropriate framework for market risk management in respect of
all assets held
Liquidity Risk •Appropriate liquidity management framework
•Able to assume that liquidity risk commensurate with their ability to
have sufficient recourse to Shariah-compliant funds to mitigate such
risks
Rate of Return •Comprehensive risk management and reporting process to assess
Risk the potential impacts of market factors affecting rates of returns on
assets in comparison with the expected returns for IAH
Operational Risk •Adequate system and controls to ensure Shariah compliance
•Appropriate mechanism to safeguard the interest of all fund
providers.
Roles of Shari’ah Board
IFIs shall have adequate system of controls
including Shari’ah governance (SG) system.
SG is a set of institutional and organizational
arrangements through which IFIs ensure that
there is independent oversight of Shari’ah
compliance.
IFIs shall have in place a Shari’ah board (SB) to
review and ensure that all financing proposals
are Shari’ah compliant at all times.
Internal/External Shari’ah review unit to assist
the SB for Shari’ah-compliance purpose.
How Shari’ah governance complements the
existing corporate governance?
Typical Financial
Functions Exclusive to IFIs
Institution
Independence
Well-defined
Operating
Procedures
Concluding Remarks
Good CG is crucial in providing effective risk
management system.
Certain types of risks are of equal concern to all
institutions offering financial services, but there are
certain specific risks which are exclusive to IFIs.
Board of Directors and Senior management have
specific roles in relation to risk management
objectives, strategies, policies and procedures in order
to mitigate all types of risks.
Shari’ah board is more concerned on the aspect of
Shari’ah non-compliance and reputational risks.
IFIs need for a set of best practices of corporate
governance and effective risk Management that give
practical effect to managing the underlying risks.
References
Ali, Salman Syed (2007). Financial Distress and Bank Failure: Lessons from Closure
of Ihlas Finans in Turkey, Islamic Economic Studies, Vol. 14, No. 1 & 2, Aug. 2006
& Jan. 2007, pp: 1-52.
ABI Research Paper 7. (February 2008). Governance and Performance in Corporate
Britain. London: The Association of British Insurers.
Black, B. S. Jang, H and Kim, W (2004). Predicting Firms CG Choices: Evidence
From Korea. University of Texas Law School Working Paper No. 39, August.
Black, B. (2001). The CG Behavior and Market Value of Russian Firms. Emerging
Market Review, Vol. 2, March.
Grandmont, R, Grant, G. and Silva, F. (2004). Beyond the Numbers- CG:
Implications for Investors, (Deutsche Bank, April 1).
Hijazi, Faisal. (2009). Global Sukuk Issuance: 2008 Slowdown Mainly Due to Credit
Crisis and Some Impact on Shari’ah compliance issues. International Structured
Finance Special Report.
IFC and Hawkamah. (2008). A Corporate Governance Survey of Listed Companies
and Banks Across the Middle East & North Africa. Washington: IFC.
IFSB Exposure Draft Guiding Principles on Shari’ah Governance System.
IFSB Guiding Principles of Risk Management For Institutions (Other then
Insurance Institutions) Offering Only Islamic Financial Services.
Thank You
Zulkifli Hasan
E-mail: zul361977@yahoo.com
z.b.hasan@durham.ac.uk
Blog: http://zulkiflihasan.wordpress.com
Tel: +44 (0) 7761457686