Risk Management – Differences Among Islamic and Conventional Financial
In evolving the Islamic financial system, important considerations range from the development of a system that is able to satisfy the changing requirements of the client and business community, that is certainly efficient and competitive, that is safe and sound and that is robust and resilient and able to tolerate a more challenging and unsure world environment. These concerns are vital to ensure the sustainability of the system not only being a form of financial intermediation inside the domestic overall economy but also as an integral component of the international financial system. 1 However the features of Islamic banks and their intermediation designs that they stick to eg the Profit and Reduction Sharing (PLS) method as well as the Non Income and Damage Sharing(NPLS) technique involves unique risks that contain to be proven to assist in producing risk management in Islamic bank more effective.
The Profit and Reduction Sharing technique:
This method of financing is very much different from the typical as it uses the concept of earnings and showing for example every time a corporate desires us to finance their project the financial institution uses the idea of Mudaraba where the bank act as investor and the corporate while the businessperson. As Islamic banking prohibits against repayment of a set or flying interest rate, this concept provides a risk to the traditional bank as the entire financing will be provided by your bank and the client (entrepreneur) simply provides his experience and labour, even so any profit gained with this project will probably be shared between the bank (investor) and the customer (entrepreneur). However, if should the the project have been completely mismanaged thus resulting in getting a lesser profit, the profit will probably be share amongst both parties because agreed in accordance to the arranged profit writing ratio. Even so if inside the even there is a failure together with the project as a result arising within a ed
Not Profit Posting Method:
This concept of financing is utilized where the Profit and Loss Sharing method cannot be employed eg intended for the funding of little traders or personal loans. Even though it may be much less risky compared to the Profit Sharing method NPLS also contains some risk such as inside the financing making use of the concept of Bai Salam in which the buyer pays off the seller the full agreed value of a asset or product where the vendor will deliver at a future date. Even so there is the element of payment and commodity exposure to possible the bank while the bank has pay the seller upfront and only obtain the products at an decided future date and what would happen if the price of the commodity drops such as the current palm oil product. In further to the previously mentioned two you will discover other factors of risk helping to make Islamic bank more high-risk and less lucrative as compared to standard banking and there are:
Foreign Exchange Rates:
In terms of the above Islamic banking companies will find this more challenging in come out with progressive products to compete with the traditional banking as the Shariah does not permit the use of Riba or gharar for their risk hedging devices. Thus business owners will find that less appealing and competitive for employing their trade services where their goods will say arrive in three months but desires to hedge forward their very own foreign currency. Interbank Money Market:
The problem in growing short term money based on Income and Damage Sharing method which is in compliance to Shariah hinders the Islamic banks in managing their liquidity as a result increasing their very own exposure to liquidity shock just like in the case of the current financial credit crunch.
Lender of Last Resort:
Because compare Standard banking where banks can relay on the Central bank to come in as loan provider of final measure if there is a run in the bank or perhaps if the traditional bank is in liquidity problem, the LOLR coming from central traditional bank instruments which are in compliance to Shariah is very limited thus limiting the access into this facility. However Bank Negara Malaysia allow us an innovative...