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Risk Management Essay

4636 words - 19 pages

Risk Management in Islamic and Conventional Banks:
A Differential Analysis
Salman Ahmed Shaikh*
Dr. Amanat Ali Jalbani
Abstract
Islamic banking is interest-free banking which makes it necessary for Islamic banks to
take active part in the operations of the business, i.e. share profits as well as losses.
Banks including Islamic banks prefer to take minimum risk. On the surface, it may seem
that Islamic banks face more risk and hence, will have more volatile or even negative
returns on their assets.
This paper analyzes the risk management procedures of Islamic banks by giving a
differential analysis of risk management discussing only the unique characteristics of
risk management in ...view middle of the document...

This research paper discusses risks faced and managed by Islamic Banks in ways
different from conventional banks. The specific risks analyzed include reputations risk,
exchange risk, price risk, operational risk, default risk, religious risk, concentration risk
and liquidity risk. It gives us insights into:
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How the Islamic banks manage reputation risk when they are alleged to be
involved in terrorism financing?

*Salman Ahmed Shaikh is working as SO II in Meezan Bank Limited, Karachi.
Dr. Amanat Ali Jalbani is a Professor at SZABIST, Karachi.
Journal of Independent Studies and Research – MSSE

Volume 7

Number 2

Electronic copy available at: http://ssrn.com/abstract=1530393

July 2009 67

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How do they manage exchange risk when currency options and currency swaps
are not allowed in Islamic banking?
How do they manage price risk and operational risk while exposed to fluctuations
in the market?
How do they manage default risk when rescheduling of an NPL is not allowed
in Islamic banking?
How do they manage liquidity risk as the intermediary function Islamic banks
perform does require more time and thorough analysis to place funds.
How do they manage concentration risk as 60% of the financing provided by
Islamic Banks is by way of Murabiha facility?
How do they manage religious risk as few scholars do not approve of Islamic
Banking being compatible with Islamic principles?

Islamic Banking in Pakistan was introduced during General Zia's regime in the 1980s.
Since then, it has developed rapidly. Meezan Bank, Dubai Islamic Bank, First Dawood
Islamic Bank, Bank Al-Baraka, Emirates Global Islamic Bank and Bank Islami are full
fledged Islamic banks operating in Pakistan. A lot of local and foreign scheduled banks
have started Islamic banking windows and exclusive Islamic banking branches. According
to the State Bank of Pakistan Strategic Vision 2010 Report published in March 2009,
it is expected that Islamic banking in Pakistan will capture 12% of the banking industry
assets and deposits by 2012.
1.2. Problem Statement
Islamic banks cannot merely lend money to earn interest as interest is prohibited in
Islam based on Quranic injunctions. Islamic banks are obliged to take active part in the
business and opt for sharing profits as well as losses since interest based investments
and borrowings are not permitted in Islam. Since, Islamic banks can not charge a fixed
return unrelated with their client's operations, It may seem that Islamic banks face more
risk and hence, will have more volatile returns on their assets as they have to own the
asset before they sale or lease it to their clients and take on subject matter risk which
conventional banks do not take. This paper probes into whether Islamic banks are riskier
than conventional banks or not.
2. Research Methodology
It is an exploratory as well as an empirical research. It introduces the specific risk
management...

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