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Thursday, December 29, 2011

Risk Profile of Islamic Bank

In the real world of Islamic bank, it faces two types of risk profile namely as generic and unique risk profile.
The generic risk profile
  1. Credit risk: The uncertainty that counterparty (borrower) fails to exercise its obligations in consonance with agreed terms and conditions of a credit-related instrument.
  2. Market risk:  The uncertain impact of unexpected price movements in the market such as benchmark rates, foreign exchange rates, equity prices on the economic value of an asset.
  3. Liquidity risk: The potential loss arising from the bank’s failure to meet its obligations or to fund increases in assets as the fall due without incurring unacceptable costs or losses.
  4. Operational risk: The potential loss which results from inadequacy or failure in internal process, people and system or external events.
The generic risks are not a straightforward in Islamic banking world. In example, for financing assets such as murabahah, salam, istisna’ and ijarah, the risks of financing may transform from credit to market or vice versa at respective stages of the contract.
Therefore, the capital management needs to take into account both the credit and market risk.
The unique risk profile
  1. Syariah non-compliant risk: caused from the failure to adhere with the Syariah rules and principles.
  2. Rate of return risk: the potential impact on the returns resulted from the unexpected change in the rate of returns.
  3. Displaced commercial risk: the risk that the bank may face commercial pressure to pay returns that exceed the rate that has been earned on its assets financed by investment account holders. With this, the bank may forgo part or its entire share of profit in order retains its fund providers and dissuades them from withdrawing their funds.
  4. Equity investment risk: resulting from entering into a partnership for the purpose of contract undertaking in business activity as described in the contract, and in which the capital provider shares in business risk (e.g. mudharabah & musharakah)

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