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Article
Publication date: 11 January 2021

Syed Alamdar Ali Shah, Raditya Sukmana and Bayu Arie Fianto

This study aims to propose a risk management framework for Islamic banks to address specific risks that are unique to Islamic bank settings.

Abstract

Purpose

This study aims to propose a risk management framework for Islamic banks to address specific risks that are unique to Islamic bank settings.

Design/methodology/approach

A unique methodology has been developed first by exploring the dynamics and behaviors of various risks unique to Islamic banks. Second, it integrates them through a series of diagrams that show how they behave, integrate and impact risk, returns and portfolios.

Findings

This study proposes a unique risk-return relationship framework encompassing specific risks faced by Islamic banks under the ambit of portfolio theory showing how Islamic banks establish a steeper risk-return path under Shariah compliance. By doing so, this study identifies a unique “Islamic risk-return” nexus in Islamic settings as an explanation for the concern of contemporary researchers that Islamic banks are more risky than conventional banks.

Originality/value

The originality of this study is that it extends the scope of risk management in Islamic banks from individual contract-based to an integrated whole, identifying a unique transmission path of how risks affect portfolio diversification in Islamic banks.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 14 no. 3
Type: Research Article
ISSN: 1753-8394

Keywords

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Article
Publication date: 14 September 2015

Romzie Rosman and Abdul Rahim Abdul Rahman

The purpose of this study is to examine the nature of the risk management practices of Islamic banks as recommended by the Islamic Financial Services Board (IFSB) in…

Abstract

Purpose

The purpose of this study is to examine the nature of the risk management practices of Islamic banks as recommended by the Islamic Financial Services Board (IFSB) in managing their unique risks. This study also explores the differences in risk management practices based on the country, size, type and age of the bank.

Design/methodology/approach

A questionnaire was developed to investigate the risk management practices. The main reference for the questionnaire was the IFSB Guiding Principles of Risk Management and the respondents were either the chief risk officers or holders of other senior positions involved in risk management in the Islamic banks. A non-parametric test was then conducted to explain the difference in mean scores for the unique risk management practices by the Islamic banks.

Findings

A lack of effective risk management practices was found in relation to liquidity risk, displaced commercial risk and equity investment risk by Islamic banks. However, Islamic banks were comparatively good in managing operational risk/Shari’ah non-compliance risk. The study found that there was a significant difference in the practice of equity investment risk management based on the size, type and age of the Islamic bank. In addition, a significant difference was found between the Islamic banks in the Middle Eastern and North African (MENA) and Asian countries concerning the practice of both displaced commercial risk and operational risk/Shari’ah non-compliance risk management.

Research limitations/implications

In spite of the limitations in non-parametric analysis, this analysis was preferred inasmuch as the data were measured on an ordinal scale with a small sample size.

Originality/value

This study is among the few studies that examine and explore the risk management practices of Islamic banks internationally by explaining the unique risks encountered in Islamic finance.

Details

Journal of Islamic Accounting and Business Research, vol. 6 no. 2
Type: Research Article
ISSN: 1759-0817

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Article
Publication date: 6 April 2010

Erwin G. Hutapea and Rahmatina A. Kasri

The purpose of this paper is to examine the relationship between Islamic bank margin (BM) and its determinants. It also compares the BM behavior of Islamic and…

Abstract

Purpose

The purpose of this paper is to examine the relationship between Islamic bank margin (BM) and its determinants. It also compares the BM behavior of Islamic and conventional banks in the Indonesian dual banking system.

Design/methodology/approach

The paper employs a time series approach under the dealership framework of Ho and Saunders. The autoregressive distributed lag model is used to inspect cointegration between BM and its determinants for the period of January 1996 to February 2006 of five sample banks (two Islamic banks and three conventional banks).

Findings

The result confirms that there exists a long‐running relationship between the Islamic BM and its determinants. In particular, as interest rate volatility increases, Islamic BM responds negatively while that of conventional banks responds positively. The findings differ from most of the other studies as they found a positive relationship between BM and interest rate volatility. This paper also shows that the margin behavior changes as the basis of bank operations changes from conventional to Islamic principles.

Research limitations/implications

The paper uses a relatively small sample of three (out of 150) conventional banks as a comparison to two sample Islamic banks. However, as they come from the same peer with the Islamic banks, it is believed that the finding is valid. Islamic banks in Indonesia are not remote from the interest rate volatility in their presence under a dual banking system. It is the displaced commercial risk that threatens Islamic banking profitability in a changing market interest rate situation.

Practical implications

Under a dual banking system, the stability of interest rates and the financial system is of great importance for the policy maker in developing the Islamic banking industry in Indonesia. As long as the BM is still a major source of income to the Islamic banks, it is necessary for Islamic banks to have prudent risk management to mitigate the negative effect of displaced commercial risk and maintain its profitability. Implementation of profit equalization reserves concept is a possible measure for Islamic banks to shield their operation.

Originality/value

This paper is believed to be the first study on Islamic BM behavior in Indonesia. It is expected to provide useful information for policy makers and Islamic bank management to develop a sound and profitable Islamic banking industry in Indonesia.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 3 no. 1
Type: Research Article
ISSN: 1753-8394

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Article
Publication date: 7 January 2020

Othmane Touri, Rida Ahroum and Boujemâa Achchab

The displaced commercial risk is one of the specific risks in the Islamic finance that creates a serious debate among practitioners and researchers about its management…

Abstract

Purpose

The displaced commercial risk is one of the specific risks in the Islamic finance that creates a serious debate among practitioners and researchers about its management. The purpose of this paper is to assess a new approach to manage this risk using machine learning algorithms.

Design/methodology/approach

To attempt this purpose, the authors use several machine learning algorithms applied to a set of financial data related to banks from different regions and consider the deposit variation intensity as an indicator.

Findings

Results show acceptable prediction accuracy. The model could be used to optimize the prudential reserves for banks and the incomes distributed to depositors.

Research limitations/implications

However, the model uses several variables as proxies since data are not available for some specific indicators, such as the profit equalization reserves and the investment risk reserves.

Originality/value

Previous studies have analyzed the origin and impact of DCR. To the best of authors’ knowledge, none of them has provided an ex ante management tool for this risk. Furthermore, the authors suggest the use of a new approach based on machine learning algorithms.

Details

International Journal of Emerging Markets, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1746-8809

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Article
Publication date: 30 March 2012

Rifki Ismal

The purpose of this paper is to formulate both withdrawal risk and bankruptcy risk to mitigate the risks and to find the equilibrium area of revenue sharing to depositors…

Abstract

Purpose

The purpose of this paper is to formulate both withdrawal risk and bankruptcy risk to mitigate the risks and to find the equilibrium area of revenue sharing to depositors. Taking the case of the Indonesian Islamic banking industry, this work might benefit the Islamic banks, banking regulators and all stakeholders to manage the risks and maintain the robust development of the industry.

Design/methodology/approach

First, the application of revenue sharing ratio in Islamic banks is studied. Withdrawal risk might happen because of the displaced commercial risk and bankruptcy occurs when the banks fail to manage such withdrawal risk. Referring to that, by using a mathematical approach, the formulas of withdrawal risk and bankruptcy risk are created with some underlying scenarios. Finally, mathematical formula and three dimensions area of the equilibrium revenue sharing ratio are developed.

Findings

The paper generates the financial mathematical formulas to assess the vulnerable and invulnerable conditions of the withdrawal risk and the bankruptcy and solvency conditions of the bankruptcy risk to be used by decision makers to mitigate the risks. The ultimate output of the paper is the equilibrium area of the revenue sharing ratio, which locates Islamic banks in a proper condition of no withdrawal risk and bankruptcy risk.

Originality/value

To the best of the author's knowledge, this is the first paper trying to analyze the issues under the Indonesian case.

Details

International Journal of Islamic and Middle Eastern Finance and Management, vol. 5 no. 1
Type: Research Article
ISSN: 1753-8394

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Article
Publication date: 16 April 2010

Simon Archer, Rifaat Ahmed Abdel Karim and Venkataraman Sundararajan

The aims of this paper are: first, to draw attention to the issues of displaced commercial risk (DCR) which arise as a result of the risk characteristics of profit‐sharing…

Abstract

Purpose

The aims of this paper are: first, to draw attention to the issues of displaced commercial risk (DCR) which arise as a result of the risk characteristics of profit‐sharing investment accounts (PSIA), the main source of funding of Islamic banks in most jurisdictions; and, second, to present a value‐at‐risk approach to the estimation of DCR and the associated adjustments in capital requirements.

Design/methodology/approach

The paper is based on empirical research into the characteristics of PSIA in practice, which vary to a greater or lesser extent from what one would expect them to be in principle, on an analysis of the capital adequacy and risk management implications that flow from this, and on an econometric formulation whereby the extent of DCR in Islamic banks may be estimated.

Findings

The findings are, first, that the characteristics of PSIA can vary from being a deposit like product (fixed return, capital certain, all risks borne by shareholders) to an investment product (variable return, bearing the risk of losses in underlying investments), depending upon the extent to which the balance sheet risks get shifted (“displaced”) from investment account holders to shareholders through various techniques available to Islamic banks' management. Second, the paper finds that this DCR has a major impact on Islamic bank's economic and regulatory capital requirements, asset‐liability management, and product pricing. Finally, it proposes an econometric approach to estimating DCR but report that individual Islamic banks generally lack the data needed to apply this approach, in the absence of which panel data for a population of Islamic banks may be used to estimate DCR for that population.

Research limitations/implications

Empirically, the paper is thus limited by the lack of data just mentioned. Furthermore, the application of the proposed panel data approach has been left for future research.

Originality/value

The analysis of the issues and the development of the econometric model represent in themselves an original research contribution of some significance.

Details

Journal of Islamic Accounting and Business Research, vol. 1 no. 1
Type: Research Article
ISSN: 1759-0817

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Book part
Publication date: 14 December 2018

Shatha Qamhieh Hashem and Islam Abdeljawad

This chapter investigates the presence of a difference in the systemic risk level between Islamic and conventional banks in Bangladesh. The authors compare systemic…

Abstract

This chapter investigates the presence of a difference in the systemic risk level between Islamic and conventional banks in Bangladesh. The authors compare systemic resilience of three types of banks: fully fledged Islamic banks, purely conventional banks (CB), and CB with Islamic windows. The authors use the market-based systemic risk measures of marginal expected shortfall and systemic risk to identify which type is more vulnerable to a systemic event. The authors also use ΔCoVaR to identify which type contributes more to a systemic event. Using a sample of observations on 27 publicly traded banks operating over the 2005–2014 period, the authors find that CB is the least resilient sector to a systemic event, and is the one that has the highest contribution to systemic risk during crisis times.

Details

Management of Islamic Finance: Principle, Practice, and Performance
Type: Book
ISBN: 978-1-78756-403-9

Keywords

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Article
Publication date: 26 July 2013

Hichem Hamza and Zied Saadaoui

This paper aims to examine the relationship between the volume of investment deposits and capitalization of Islamic commercial banks.

Abstract

Purpose

This paper aims to examine the relationship between the volume of investment deposits and capitalization of Islamic commercial banks.

Design/methodology/approach

Unlike current accounts holders, investment accounts holders may support part or all of the losses on assets value, which could be a source of moral hazard among bank managers and shareholders. To test these assumptions, the authors use the system generalized method of moments (system GMM) on a dynamic panel of 59 Islamic banks observed during the period 2005‐2009.

Findings

After controlling for a set of variables that may influence capital level, the results show a significant negative relationship between PSIA and regulatory capital ratio. This may indicate that the specific nature of PSIA can be a source of excessive risk‐taking in Islamic banks. This behavior is likely to threaten the solvency of Islamic banks and shows that some deficiencies may exist in their risk management and governance system.

Practical implications

This paper suggests some recommendations to better implement the principle of profit and loss sharing and to curb excessive risk‐taking in Islamic banks.

Originality/value

The originality of this paper is to give empirical responses to theoretical assumptions of a relationship between PSIA and moral hazard in Islamic banks.

Details

Studies in Economics and Finance, vol. 30 no. 3
Type: Research Article
ISSN: 1086-7376

Keywords

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Book part
Publication date: 7 October 2011

Kaouther Toumi, Jean-Laurent Viviani and Lotfi Belkacem

The income is attributed to PSIAU holders after setting aside the reserves (PER and IRR) and deducting the bank's share of income called mudarib share.

Abstract

The income is attributed to PSIAU holders after setting aside the reserves (PER and IRR) and deducting the bank's share of income called mudarib share.

Details

Finance and Sustainability: Towards a New Paradigm? A Post-Crisis Agenda
Type: Book
ISBN: 978-1-78052-092-6

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Book part
Publication date: 29 December 2016

Mahfod Aldoseri and Andrew C. Worthington

The purpose of this chapter is to review the risks Islamic financial institutions face in an emerging market context, including risk sharing in Islamic financing and…

Abstract

The purpose of this chapter is to review the risks Islamic financial institutions face in an emerging market context, including risk sharing in Islamic financing and Shari’ah (Islamic law) compliance risk. We explore current risk management practices and establish the link between risk management and the financial performance of banks and the efficiency and effectiveness of financial sectors in emerging markets. Because of their distinctive risk profile, Islamic finance institutions face challenges in risk management. We show that Islamic banking is riskier in emerging markets because of the presence of immature money markets, limitations in the availability of lender of last resort facilities, and deficiencies in market infrastructure. There is also no evidence that Islamic banks have developed effective solutions for managing the risks conventional banks face as well as their own unique risks. We suggest that the countries that do this best are those that prioritize the structure of risk management knowledge and capabilities in a single financial regulator.

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