A firm’s business (whether Islamic or Conventional) has to take care calculated risks. With this, risk management is not the minimization losses but rather than the optimization of the risk reward equation which move in two different ways.
In the real world, the competitive advantage of a firm is highly dependent on how well it manages its risk.
Risks are defined as uncertainty of future events which could influence the performance of the firm’s objectives, including strategic, operational, financial and compliant objectives.
Examples of the uncertain future events are in the below-lines:
- Failure of a borrower to repay
- Fluctuation of foreign exchange rates
- Fraud and system faulty
- Non-compliance with tabi’ law (man-made law) and Syariah law
- Or any other events that may result in a loss to firms.
Failures of risk management will result a huge financial loss to the firms and also to the overall economy of the country. There were few examples of risk management failures:
- Barings / Nick Leeson (1995)
- National Australia Bank (2004)
- Allied Irish Bank / John Rusnak (2001)
- LTCM, Hedge Fund (1998)
- Sumitomo / Yasuo Hamanaka (1996)
- Orange County, CA, USA (1994)
- Societe Generale, France (2008)
- The 2008 Financial crisis
In overall, there are few factors in consensus as in the following lines:
- Lack of senior management / board oversight.
- Weak risk culture.
- Marginalization of risk management function
- Too dependent on quantitative tools / methodologies
- Improper liquidity management
- Less relevant internal valuation model.
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