Managing Islamic banking risks.pdf

Banking and Capital Markets

Growing pains:

Managing Islamic

banking risks*

*connectedthinking

Contents

Introduction

Overview

Risk management challenges

Displaced commercial risk

Liquidity risk

Real estate risk

Operational risk

Fiduciary and reputational risk

Capital management and Basel II

What the future holds for risk management

in Islamic banking

How PricewaterhouseCoopers can help

Appendix

Contacts

Growing pains: Managing Islamic banking risks • PricewaterhouseCoopers 01

Introduction

While conventional banks are in the midst of the worst

inancial crisis in living memory, the Islamic banking

sector remains an oasis of relative calm and prosperity.

Shariah law precludes Islamic institutions from getting

involved in the kind of complex credit trading that has

paralysed their conventional competitors – but that’s no

reason for complacency. Islamic banks have their own

blind spots and frailties.

Global assets of Islamic inance

$bn, assets at end 2006

Takaful 2%

Equity funds 3%

Islamic banks tend to have signiicant concentrations

of exposure to local real-estate markets – much of it in

the form of equity-like investments. They also have a

preponderance of long-dated assets and a shortage

of instruments with which to manage their short-term

liquidity needs; Islamic banks are heavily reliant on the

loyalty of their depositors. The contractual complexity

of Islamic banking transactions gives rise to awkward

operational risks, and the uncertainties associated with

Shariah compliance leave them exposed to iduciary and

reputational risk.

Sukuk issues

outstanding 8%

16 10

Investment

banks 12%

397

Commercial banks 75%

To tal assets at end 2006: $531bn

Source: International Financial Services London, ‘Islamic Finance 2008’,

January 2008.

Risk management has not been uppermost on the

Islamic banking sector’s agenda in recent years.

Understandably, the focus has been on growth

and on the struggle to innovate and compete in this

increasingly competitive market. Shariah-compliant

assets worldwide are approaching $600 billion and

have been growing at more than 10% per year over

the past 10 years. There is still huge untapped potential.

Standard & Poor’s has estimated that the market has

a potential size of $4 trillion. 1

Shariah-compliant assets

worldwide are approaching

$600 billion. There is still huge

untapped potential.

Written by PricewaterhouseCoopers 2 experts from

around the world, this is the second paper in a series

dedicated to Islamic inance. It offers a primer for people

not familiar with Islamic inance and banking products.

It examines the risks associated with those products

and with Islamic banking as a whole. It also looks at

the future of risk management in this sector and the

forces shaping it.

Conventional banks also want to know that Islamic

banks make robust counterparties. If Islamic banks

are serious about playing a greater role in the inancial

system, they will need to get to grips with risks which

may not currently be well understood or well managed.

The time to ix the roof is when the sun is shining:

Islamic banks should be dusting their ladders off now.

1 International Financial Services London, ‘Islamic Finance 2008’,

January 2008.

2 PricewaterhouseCoopers’ refers to the network of member irms of

PricewaterhouseCoopers International Limited, each of which is a separate

and independent legal identity.

Growing pains: Managing Islamic banking risks • PricewaterhouseCoopers 03

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