Question

What are the issues and challenges of risk management in Islamic finance ?

Answer 1

The Islamic financial industry has a distinct familiarization towards risks. The risks are more regulated on the basis of contract types rather than risk types as a result of the special structuring of the contracts in Islamic banking. The type of Islamic banking is based on risk-sharing, owning and handling of physical goods, engagement in the process of trading, leasing and construction contracts using various Islamic modes of finance. These expose them to specific types of risks.

Several general factors that make the operation of Islamic banks riskier and thus less profitable than traditional banks are:

• Limited availability to access to LOLR facilities.

This limitation is associated with the prohibition of discount rates. A practical approach to help and solve this issue should be generated for the wider availability of Islamic banks to a stable money market.

• Legal contingencies and limited market base which restrict the availability of hedging implements.

The absence of a legal framework can raise operational risk and threaten business development.

• Weak or nonexistent money markets.

Thus, there is a need to establish systemic liquidity - domestic and international - Islamic money market for Islamic economic institutions that should be agreeable to the Shari’ah.

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