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Simon Archer
is Visiting Professor at the ICMA Centre in the School of Business, University of Reading, UK. Previously, he
was Professor of Financial Management at the University of Surrey, UK, having been Midland Bank Professor
of Financial Sector Accounting at the University of Wales, Bangor. He has been a visiting professor at various
universities and business schools, including Bordeaux, Metz, ESCP-EAP and HEC in France, Frankfurt and
Koblenz in Germany, and IIUM in Malaysia. After studies in philosophy, politics and economics at Oxford
University, he qualified as a Chartered Accountant with Arthur Andersen in London and then moved to Price
Waterhouse in Paris, where he became Partner in charge of Management Consultancy Services in France
and Scandinavia. His academic career thus began after substantial experience as a practitioner, mainly in
management consulting.
ABSTRACT This study attempts to ascertain the perceptions of Islamic bankers (chief financial officers
and risk managers) about the nature of risks, risk measurement and risk management techniques in their
banks. It covers 28 Islamic banks in 14 countries using a questionnaire survey. The results indicate that
Islamic banks are mostly exposed to similar types of risks to those in conventional banks, but that there are
differences in the level of the risks. The findings of the study have both theoretical and policy implications for
the issue of transparency, with particular reference to risk reporting in Islamic banks.
Journal of Banking Regulation (2009) 10, 153163. doi:10.1057/jbr.2008.27
Keywords: Islamic banks; nature of risks; risk management; perceptions
INTRODUCTION
The unique characteristics of Islamic banks,
which are based, among other things, on
mobilising funds through profit-sharing and
loss-bearing investment accounts, logically
Mohd Ariffin et al
154
A
A
A
A
N/A
A (high)
A (high)
A
N/Aa
A
155
Mohd Ariffin et al
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Islamic derivatives
In order to hedge the risks arising in their
activities, similar to conventional banks, Islamic
banks could consider using derivative instruments. A derivative instrument is one whose
value depends on the values of other, more
basic underlying variables. However, these
derivative instruments are not accepted by
most fiqh scholars because, they argue, all
derivatives fail to be Sharia-compliant (owing
to gharar, maysir or riba) and therefore should be
prohibited.
A number of contracts exist in Islamic
banking that could be considered a basis for
derivative instruments within an Islamic framework. These are Bai Salam, Urboun18 and
Khiyar al-Shart.19 Bai Salam is similar to the
conventional forward contract. However, the
major difference is that in a Bai Salam contract,
the buyer pays the entire amount in full at the
time the contract is initiated. The contract also
stipulates that this payment must be in the form
of cash. The buyer in a contract therefore is an
Islamic bank. Because there is full prepayment,
this potential contract is beneficial to the seller.
As such, the predetermined price is normally
lower than the potential price. The price
behaviour is certainly different from that of
conventional forward contracts, where the
forward price is typically higher than the spot
price by the amount of the carrying cost.
Credit or counterparty risks of forward and
Bai Salam contracts are therefore different.
In a Bai Salam contract, the risk would be
one-sided because the buyer has fully paid, and
therefore only the buyer faces the sellers
default risk as opposed to both parties facing
risk, as in a forward contract. In order to
overcome the potential for default on the part
of the seller, the Sharia allows the buyer to
require security, which may be in the form of a
guarantee or pledge.
It is argued by many fiqh scholars that
conventional derivatives are not permissible
because they can lead to speculation. For
example, the argument is often put forward
that the huge trading volume of derivative
RESEARCH METHODOLOGY
This study covers 28 Islamic banks in 14
countries using a questionnaire survey to obtain
the perceptions of the Islamic bankers (chief
financial officers and risk managers) about the
nature of risks, risk measurement and risk
management techniques in their banks. The
lists were taken from the International Directory of Islamic Financial Institutions issued by
the Institute of Islamic Banking and Insurance
in London, and by contacting the banks
directly by either e-mail or post. The total
number of Islamic banks were selected from
14 different countries, including Malaysia,
Sudan, Bangladesh, Pakistan and Middle East
countries. The final sample consists of 28
Islamic banks, which is considered to be
sufficient for this study because the banks
represent the most established Islamic banks in
these 14 countries.
The research questions that need to be
addressed and investigated in this study are as
follows:
K
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RESEARCH FINDINGS
The findings from the questionnaire survey,
supplemented by material from the interviews
where appropriate, will be presented in three
sub-sections: risk perceptions, risk measurement and risk management
Risk perceptions
Table 2 shows the 5-Likert scale used in the
questionnaire to ascertain the perceptions of
Islamic bankers about the importance of the
nature of risks in Islamic banks.
Table 3 presents the descriptive statistics of
the importance of the risks in Islamic banks as
perceived by the Islamic bankers, which shows
that the means are between 3.96 and 4.48.
Table 2: Scale for the importance of the risks in Islamic
banks
Scale
Classification
1
2
3
4
5
Very unimportant
Unimportant
Neutral
Important
Very important
Mean
Skewness
Chi-square
1.
2.
3.
4.
5.
6.
7.
4.48
4.10
4.00
4.21
4.19
4.10
3.96
1.511
0.684
0.375
0.302
0.804
0.663
0.882
0.000*
0.001*
0.046**
0.066***
0.010*
0.016**
0.008*
159
Mohd Ariffin et al
Rate of
return
risk
Price
risk
Liquidity
risk
Foreign
exchange
risk
Operational
risk
Sharia
non-compliance
risk
Total
Chisquare
4.10
4.56
4.49
4.00
4.48
3.55
4.18
3.90
3.70
4.25
3.48
4.41
4.11
3.76
3.86
3.93
3.63
4.25
3.96
4.27
3.74
4.13
3.82
3.83
4.38
3.72
4.18
4.05
3.86
4.14
4.00
3.81
3.85
3.85
3.85
3.79
4.14
4.06
3.85
4.17
0.000
0.000
0.000
0.000
0.000
4.29
4.19
4.42
4.29
3.86
4.11
3.96
4.14
4.29
4.05
4.37
4.25
3.88
3.95
4.16 0.000
4.14 0.000
Murabaha
Salam
Istisnaa
Ijarah
Mudaraba
(asset side)
Musharaka
Diminishing
Musharaka
Total
Malaysia
Bahrain
Others
KW
Credit risks
Liquidity risk
Foreign exchange risk
Operational risk
Rate of return risk
Price risk
Sharia non-compliance risk
4.48
4.19
4.21
4.10
4.10
4.00
3.96
4.75
4.50
4.00
4.75
4.00
4.25
4.25
4.33
4.00
4.20
3.50
3.83
3.67
3.83
4.47
4.17
4.26
4.16
4.21
4.06
3.94
N/S
N/S
N/S
N/S
N/S
N/S
N/S
29
19
Note: N/S indicates that the differences of the responses between countries are not significant at 10% using the Kruskal
Wallis test of significance.
160
Credit ratings
Gap analysis
Duration analysis
Maturity matching
Earnings at risk
Value at risk
Simulation techniques
Estimates of worst case/stress tests
Risk-adjusted return on capital
Internal-based rating system
57
68
43
82
43
29
18
43
14
46
43
32
57
18
57
71
82
57
86
54
28
28
28
28
28
28
28
28
28
28
Risk management
1.
2.
3.
4.
5.
6.
7.
8.
93
78
89
22
93
11
15
4
Collateral arrangement
Third-party enhancements
Loan loss reserves
On balance sheet netting
Guarantees
Parallel Salam contracts
Parallel Istisnaa contracts
Urboun (over-the-counter
Islamic derivatives)
7
22
11
78
7
89
85
96
27
27
27
27
27
27
27
27
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Mohd Ariffin et al
CONCLUDING REMARKS
On the basis of the findings of the postal
questionnaire survey, together with the interview findings, as discussed in the previous
section, there is evidence that different contracts have different implications for the
importance of each risk. However, there is no
evidence in the current research that Islamic
bankers in different countries perceived risks
differently. The findings also suggest that each
risk should be assessed separately for each
financial instrument in order to facilitate
appropriate risk management. The findings
show that Islamic banks are perceived to use
less technically advanced risk measurement
techniques, of which the most commonly used
162
10
11
12
13
14
15
163