Risk Management for Islamic Banks Recent Developments

386 INDEX Capital adequacy, (Continued) goods, market value/price, 329 impact, 38 liquidation, 113–114 information, 43 market value, updates, 132–133 quality, 130 Capital adequacy, Asset quality, risk-mitigation tool, 225 Management quality, Earnings, Collateralized debt obligations Liquidity (CAMEL), 319 (CDOs), 71, 246 Capital adequacy directive (CAD), 36 Collaterals, 103, 318 Capital adequacy ratio (CAR), 26, Collection ratio, 139 Commercial risk 94t –95t, 322 calculation, 66–67, 240 coverage, PER/IRR (usage), 227–230 inadequacy, 40–41 displacement, 211–212 leverage ratio, 35 Commission, receiving, 240 percentage, 245 Committee of the Sponsoring process, 222, 244 usage, 67–69 Organizations (COSO) standards, 49 Capital Adequacy Standard Commodities (IFSB revision), 321 harvest patterns, 247 Capital asset pricing model offset, 261 prices, market indicators, 259 (CAPM), 6, 8, 305 separation, 250 Capitalism, powers, 302 volatility, 249 CapitalSouth, credit channeling, 200 Commodity market Capital-to-asset ratio, 91 micro-banking approach, 307 Cash and portfolio investment to deposit real-sector return approach, 308–309 replacement cost approach, 306–307 ratio, 93t Commodity Murabahaha transaction Cash deposits machine (CDM), 202 Cash-equivalent value (accounting (CMT), 71 Commodity price, 234 measurement), 85 Cash flow increase, 236 risk, 236 decisions, 217 Common Equity Tier I (CET-1), 67–70 pattern, 136 Common shares, issuance, 68 source, 289 Common-size analysis, 90 Cash flow at risk (CFaR), 63 Comparability (information quality Cash inflow/outflow, BCBS criterion), 76 definitions, 279 Competition, increase (positive response), Cash recovery rate (CRR), 308–309 Cash-to-deposit ratio, elevation, 90–91 332 – 333 Catastrophic, 351 Competitors, entrance, 196–198 Central Bank of Bahrain, capital charge Compliance risk, 19 Composite risk index (CRI), calculation, regulation, 260–261 Central Bank of Kuwait, 190 54, 57–58 Central Bank of Malaysia Act (1958), 188 Composite risk matrix, illustration, 60f Central Bank of Pakistan (CBP), 231 Compound annual growth rate Channeling, 351 Character, capacity, capital, collateral, (CAGR), 291 Comprehensive risk measure (CRM), 242 conditions (5C), 319 Concentration risk, limitation, 138 Clarity, absence (Gharar), 174–175 Consistency (information quality Clearing settlement, 84 Collateral criterion), 76

Index 387 Consumption, process, 302–303 Debt Contracts addition, 172 contracts, 107 approach, 184 repayment, lateness, 317 creation, cost (increase), 224 trading, 78 negotiation stage, 224 schemes, 78 Debt-based contracts, 78 support, 225 characteristics, 112–113 Conventional banks usage, 286 funds, source/usage, 218t inherent risks, 59–60 Debt-based instruments Islamic banks, contrast, 10–11 absence, 285 risk categories, 58t elimination, 307 Conventional interest rate, non-interest proliferation, 286 superiority, 215–216 banking facilities (negative usage, 296–297 relationship), 306 Co-opetition strategy, 322 Debt-based sales contract, 7, 8 Core capital ratio, 95t Debt-based security, 295 Corporate governance, 92, 351 Debtors Corporate restructurization, 92, 100 Cost-benefit analysis, 57 business experience, problems, 11 Cost-revenue matching, usage, 253–254 creditors, relationships, 289, 291 Cost to income ratio, 98t database, 226–227 Countercyclical buffer (CCB), 70–71, 223 default, bank differentiation, 112 Countercyclical capital buffer, 41, 352 Islamic bank analysis, 137 Counter-party risk, 110 land certificate, value, 219 Credit multiplier, 265–267, 315 monitoring, 132 Credit risk, 17–18 negligence, conditions, 218 generation, 25–26 number, elimination, 134–135 repayment defaults, 61 selection, 108 transformation, 328 Debt ratios, implementation, 41 CreditRisk+ model, 351 Debt-taking, 301–302 Credit scoring, 351 Debt to equity ratio, 93t, 322 Cross-border products, interconnection, Debt to total assets ratio, 94t 335 – 336 Default, debtor probability, 133 Cross-sectional analysis, 90 Default risk, 108, 345 Currencies Deferred sale (Bay’ul Mu’ajjal), 117–118 changes, 232 Deferred sale contract, 118 net open position, absence, 238 Deferred tax assets, 69 Current asset ratio, 93t Deficit party, efforts (creativity), 169 Current ratio, 93t Deployment ratio, 91–92 Customer base, building, 15 Depositors, large-scale withdrawal, Customer fund withdrawal, risk (increase), 148–149 265 – 266 Customers, types, 227 Depository financial institution, 198, 200 Cut loss (policy), 351 Deposit to assets ratio, 94t, 99t Derivative instruments, 292–293 Database systems, 24, 65–66 Dayn, 4, 115, 351 Mudharat, 293 Derivative Islamic market, 292–294 Derivatives, 292 Dhaman, 351 Diminishing musyarakah, 351

388 INDEX Din, 351 External fraud, 165 Direct interconnection, 335 External funds, sources (access), 277–278 Discounted model, 7 External parties Discretionary power, 216 Displaced commercial risk, 316, 351 fraud, 150 payments, 160–161 coverage, PER/IRR (usage), 227–230 External rating assessment, basis, 140t Dividends, 68, 223 Domestic level, fatwa committee, 14–15 Fadhlu, 172 Dual banking system, 334 Fadhl usury, 173 Fairness in scales, principle, 301 single banking system, contrast, 15–16 Fat-tail loss distribution, 352 Dubai Islamic Bank (DIB), 146, 278 Fatwa, 19, 181–182 Earnings at risk (EaR), 63 committee, 14–15 E-banking services, 202 instrument, 186 Economic activity, fairness, 300–301 products, 188 Economic cycle, 247 Faysal Islamic Bank, establishment, 12 Economics exposure, 262 Feedback capability, 76 Economic value added (EVA) model, 253 Fiduciary risk, 20, 148, 316, 352 Efficiency ratio, 90, 91–92, 98t –99t occurrence, 156–160, 220 El-Najjar, Abdul Aziz Ahmad, 11 prevention, 148 Enron Corporation, financial report Financial asset transactions, 294 Financial bubbles, 301–302 manipulation, 145 Financial contracts, division, 4 Enterprise risk management (ERM), Financial crises, 319 causes/determinants, 338 48–49, 319, 351 severity/frequency, minimization, application, 65 implementation, prerequisite, 65–66 337 – 338 standards, proposal, 50 Financial inclusion, 352 Equilibrium model, 286–287 Financial industry, globalization, 331 Equity Financial institutions, interconnection, capital, consideration, 222 composition, 81–82 335 – 336 equity to assets ratio, 99t Financial instruments, bank usage, 280 equity to financing ratio, 138 Financial lease transactions, 159 equity to liabilities ratio, 94t Financial market, Treasury activity, financing, 213 liabilities, syirkah, 84–86 276 – 277 multiplier, 93t Financial product engineering, 315 price, 234 Financial ratios, usage, 138–139 risk, 238 Financial reports Escrow account, 209, 351–352 European Union, capital adequacy information quality, 76–77 manipulation (Enron Corporation), 145 directive, 36 Financial services Event, severity/frequency, 58 authority, optimization role, 320 Exchange-based contrast, 79–80 institutions, synergy, 329f Exchange rate risk, 237–238, 262–263 Financial stability, 265–267 Executing program, 352 Financial statement analysis Expected loss, 166 common-size analysis, 90 Expentancy, degree (impact), 151 cross-sectional analysis, 90 efficiency ratio, 91–92

Index 389 peer group analysis, 92 Financing to assets ratio, 93t profitability ratio, 91 Financing to deposit ratio, 93t short-term liquidity ratio, 90–91 Fiqh, 182, 352 solvency ratio, 91 tools, 89–92 comprehension, 183 Financial statements, 184 issues, authority, 190 Financial system, vulnerability, 340 limitations, 280 Financial to assets ratio, 99t principle, meaning, 169 Financing, 352 studies, 79 activity, growth, 267 Fiqh al-Mu-amalat, 188 channeling, 212 Fiqhmu’amalah (disappearance), 207 commitment, 138 Fiqh ulama (opportunity), 178 debtor selection, 110 Fiqih mu’amalah, 155 intermediate-term financing, 80 Foreign currency long-term financing, 80 open position, limit, 254 loss coverage ratio, 94t treatment, 261 proposals, risk-and-return profiles, 87 Foreign exchange rate, 234, 247, 254 quality, measurement, 139 Fraud, 352 ratio, impairment, 139 Tadlis, 175 short-term financing, 80 Frequency (events), 58 usury-free mode (interest-free mode), Funds allocation, 171 109 management activity, 101 Financing assets manager, Mudharib role, 224 sources, access, 277–278 bank classification, 130 utilization, 86 nonperforming asset categorization, zero cost, 86 132 – 133 Gambling (Maysir), 173–174, 286 securitization, 324 Geographical spread, 92 Financing contracts Gharar, 17, 352 categories, 79–80 composition, 82 ambiguity, 286 recordation, 101 avoidance, 68 Financing portfolio elements, 5 concentration risk, 133–135 imperfect information, 17 cycle management, 137f occurrence, 175 exposure, risk contribution, 134 presence, Islamic prohibition, 17 formation, 133, 136–137 prohibition, 339 management, 135–139 Rasulullah prohibition, 174–175 rebalancing, 135–137 removal, 174–175 Financing risk, 17–18, 108 risk-taking, 315 accommodation, 132–133 speculation, 62 control, financial ratios (usage), vagueness/lack of clarity, 109, 172, 138 – 139 174 – 175 definitions/scope, 110–112 Ghubn, 352 determinant factors, defining, 114–128 Giro accounts, deposits (amounts), 88 information, impact, 214 Glass-Steagall Act, 297 occurrence, 122 Global financial crisis (2007), 67, provisions, 130–133 reduction, 142 338 – 339

390 INDEX Global financial reform package (BCBS), Hijrah, 11, 352 320 – 321 Hilah, 170, 352 Hilatul-riba, 352 Global financial risk, 296–298 Global Islamic banking entities, 12–16 shadow usury, 256 Global markets, integration (increase), Hisbah (purpose), 177, 299 233 change, 178 Global sukuk asset value, 291 Syari’ah supervisory board, Gold function, 180 exchange, 263 Historical cost, 86, 240 foreign currency treatment, 261 Human capital, development, 14 Gold orchard, creation, 181 Humanity principle, application, 310 Goods Human ownership, 171 delivery, 173 Human resources responsibility, transfer, 121 Goodwill, 69 capability, development, 15 Governance Standard for Islamic risks, 147 Financial Institution (GSIFI), 44 Idiosyncratic risk, 352 Granularity, 111, 352 Ihtihsan, 79, 352 Gross impaired financing ratio, 97t Ijab-qabul, 184, 352 Gross income, calculation, 164 Ijarah, 352 Grouping process, 163 Guarantee, 138 financing, 125 Gulf Cooperation Council (GCC) Ijarah-based financing scheme, 254 leasing, 87, 107, 304, 309 countries, studies, 229 pricing, 309–311 rent/lease, 4, 207 Hadith, 27, 262, 352 risk-weight, 142 Haircut trade, 79 treatment, 83–84 internal haircut, impact, 142 Ijarah contract, 125–128, 158–159 policy/strategy, 352 foreign exchange risk exposure, 257 Hajjah, 352 Islamic bank usage, 125 Halal, 327, 352 leasing, 11 Halal-haram approach, 184 usage, 289, 291 Hamish jiddiyah, 352 Ijarah contract risk Hanafi School, 79 factors, mitigation methods, 129t Haram, 81–82, 352 mitigation, 237 Hawalah, 4, 352 Ijarah mumtahia bi tamlik (IMBT), 109, Hazard, definition, 153–154 Headline risk, 148–149 353 Hedging, 84 capital lease, differences, 127t instruments, weakness, 239 contract scheme, illustration, 128f Hell, threat, 171 Ijarah wal iqtina’, 110 Hibah (gift contract), 229 Ijarah wal musyarakah mutanaqishah, High-cost assets, 83 Higher Syari’ah Authority (HSA), 109 Ijma’, 173 establishment, 192 Ikhraha, 5, 353 High-powered money, creation, 3 Ikhtiar, 17, 353 High return, concept, 133–134 Illegal force, 175 High risk, concept, 133–134 Illiquid instruments, impact, 248

Index 391 Imports, financing, 109 interest-based return, profit-loss sharing Incentive-compatible contract, 225–227 (contrast), 6–8 Income statement, analysis, 87–88 Income to expense ratio, 98t interest-free financial products, 10–11 Incremental risk charge (IRC), 240, 242 rate, increase, 236 Independent rating agency, urgency, 128 usury, prohibition, 302–303 Indonesian Council of Ulama Interest-based facility, 279 Interest-based indices, 306 (NSN-ICU), 191 Interest-based monetary policies, 316 Indonesian Financial Services Authority Interest-based monetary system, (IFSA), 191, 294 impact, 300 Indonesia, Syari’ah governance, 191 Interest-based system, 339 Infaq, 10 Interest-free financial system, 296 Inflation (market indicator), 259 Intermediate-term financing, 80 Information Internal control (Basel II pillar II), 38–39 Internal control systems, 103 asymmetry, 110–111, 317 Internal fraud, 154–155, 165 credibility, 110–111 Internal funding, availability dissemination, 331 imperfection, 17 (absence), 277 quality, criteria, 76–77 Internal funds, sources (access), 277–278 Information opacity, 353 Internal haircut, impact, 142 Information technology (IT) Internal model approach (IMA), installment, 150 systems, 64–65 usage, 249 usage, 147 Internal rate of return (IRR), ING DiBa, lesson, 196 Inherent instability, 300 usage, 227–230 Inherent risk, 59–60 Internal rating-based (IRB) approach, Injustice, 175 Innovation, challenges, 201–202, 202t 37, 141 Insider trading, 353 Internal ratings-based (IRB), 353 Instability factor, 300 International Capital Market Association Institutional-based development (ICMA), 277–278 framework, 295–296 International Financial Reporting Intangible assets, 69 Integrated Islamic risk management, Standard (IFRS), 68 International Islamic Bank for Investment landscape, 329–330 Interbank payment systems, failure, 336 and Development in Egypt, 346 Interconnection International Islamic Financial Market development, 34 (IIFM), 277–278, 320 relationships, 341 International level, fatwa committee, risk, 335–336 Interdependent debtors, financing 14 – 15 International Organization for exposure, 138 Interest Standardization (ISO) 31000, 49–50 Intra-industry competition, 100–101 application, Syari’ah prohibition, 10 Investment interest-based pricing model, criticism, accounts, restrictions, 87–88 299 – 300 capital, addition/withdrawal, 85–86 failure, risks (impact), 210–211 outcome, time value of money (relationship), 303 profit-sharing scheme, 303 restrictions, 81

392 INDEX Investment account holder (IAH), 227 development, prospects/challenges, customers, return (distribution), 230 323 – 324 interests, 148 financial ratios, 93t –99t Investment-based saving/deposit products, financial reporting/analysis, 72 286 global crisis impacts, 338–339 internal issues, 317 Investment risk, 20, 213, 327 investment risk, 209 absorption, 346 Islamic principles, compliance, concept, 210–216 exposure, 212–214 175 – 176 information, impact, 214 liquidity risk, 264 mitigation, 226t market risk, 232, 253–256 operational issues, impact, 232 operational risk, 14r profit sharing, 212–214 performance, 306 pricing model, development, 299 Investment risk reserve (IRR), 219, 229, regulation, 319–323 326 regulatory agenda, future, 333–335 reverse correlation, 91 Investment to equity and deposit ratio, 99t risk management Investment to liabilities ratio, 99t Iqaalah, 353 financing, urgency, 108–109 Islam history, 33 process, 47 discounted model, 7 standardization regulatory/supervisory money, 7 time value of money, 7 framework, 334 usury, prohibition, 169 strategic risk, definition/scope, 195–196 wealth, 171 Syari’ah audit process, 185–187 Islamic accounting, 75–76, 130–131 Islamic banking risk Islamic bank balance sheet financing, 108 example, 271t identification process, 56–57 form, ideal, 86–87 Islamic banking window, usage, 15–16 functionality basis, 85t Islamic bank risk, 17–20, 28, 152–153 liquidity management, 271–272 categories, 58t liquidity profile basis, 83t exposure, 91 Islamic bank financing identification, approaches, 28 business process, 112f integration, 16–20 contracts, 79 measurement/reporting, 26 portfolio, 135–136 mitigation, 26–27, 101–102 risk, measurement, 139–143 reduction, 33–34 scheme, 258 Islamic bank risk management, 9, 44 Islamic banking application, 26 activities, market risk, 235f documentation, 62–63 agenda, future, 328 importance, 28–29 challenges, 317–319 model, 47–55 characteristics, 82 organs, composition, 63–64 competency/competitiveness, 331–333 pathways, 316 competition, increase (positive process, initiation, 51–52 Islamic banks, 315–317 response), 332–333 accounting standards, 43–44 constant development, awareness, activity, prohibition, 184 331 – 332 customers, types, 227

Index 393 assets, 271–272 organizational culture, building, 22 bottom-up approaches, 23f organizational structure, 22–24, capital components, categorization, 68 common shares, issuance, 68 63 – 64 competition, 204–205 organization-based risk mapping, competitive advantage, development 24 – 26 (strategy), 100f performance, impact, 59 compliance risk, 19 philosophy, building, 22 contracts, 78–80, 207–208 pricing mechanism, urgency, 314 conventional bank, contrast, 10–11 rate of return risk, 19–20 core business activity, 92–101 rating provisions, 130–133 credit risk, 17–18 real goods/services, 10–11 database system, preparation, 24 reputation, 208 database systems, 65–66 reputational risk, 19, 208 efficiency, increase, 333 resilience, 315–316 equity holders, rate of returns specialization, 206–208 strategic risk, 19 (provision), 91 supervisory haircut, 141t fiduciary risk, 20 Syari’ah compliance, integration, financial statements, scope, 74–78 funds, sources/usage, 219t 176 – 177 Syirkah-based contract usage, 212 matching, 87t Syirkah trait, 209–210 governance, 44 top-down approaches, 23f history, 11–12 transparency, 101–102 ideological factors, 195 Islamic capital market, 286–292 Ijarah contract usage, 125 development, 292 income, 148 products, 295 information technology (IT) supervision, 294 Islamic derivatives market, 286 systems, 64–65 Islamic Development Bank (IDB), infrastructure/facilities, 62–66 inherent risk, 59–60 12–13, 278 instruments, 78–80 Islamic economics, principles, 169 investment concept, 211 Islamic Economy Conference, 12 investment risk, 20, 214 Islamic economy, wage pricing, 311f legal risk, 18–19 Islamic ethical business, conducting, liabilities, 271–272 line of business usage, 161–162 336 – 338 liquidity risk, 18 Islamic finance management, 272–281 principles, 5–6, 301 management, hurdles, 279–280 risk-free assets, usage, 7–8 loss, effects, 150 securitization principles, 256 management strategies, selection, 50 Islamic financial contracts, 3–4 market risk, 18 fixed rate, 257 measurement, 244–253 operational risk, 155–160 scope, 234–238 Islamic financial firms, capital noncompliance, impact, 146 off-balance sheet activity, 101–103 investment, 69 operation, 147–148 Islamic Financial Institution (IFI), 189f operational risk, 18, 145–149 Islamic financial institutions purpose, 184

394 INDEX Islamic financial institutions (Continued) Islamic pricing model, 299–302, 305–314 synergy/integration, 205–206, Islamic principles, integrity (preservation), 330 – 331 systemic risk, contrast, 205–206 314 Islamic risk management, evolution, 21f Islamic financial market Islamic stock market, 287–288 development, 285 Islamic window, 144 instruments, 286–287 Istishna’, 353 regulatory/supervisory, 294–295 risk factors, mitigation methods, 125t Islamic financial product, replacement sale-based contracts, 72 cost approach, 306–307 treatment, 83–84 Istishna’ contract, 122, 158 Islamic Financial Services Board (IFSB), independence, 158 13–14, 319 price risk, 262 scheme, illustration, 122f capital adequacy ratio, usage, 67–69 ’Iwad, 353 Capital Adequacy Standard (revision), Jahalah (elements), 174 321 Jahiliyah, 173 establishment, 14 Joint financing, 353 guiding principles, 232 Joint venture, 353 IFSB-2 standards, 45 Ju’alah, 353 IFSB-15, 45–46, 349 Judicial institutes, absence, 318–319 market risk, 240–244 Justifiable investments, 87–88 principles, 348–349 risk management framework, 46 Kaafil, 113, 227, 353 role, 44–46 Kafalah, 353 Syari’ah governance, 179 Islamic financial system, 168 execution, 113 banking system support, 286 funds, 225 integration, 334 guarantee, 108, 113, 303, 329 interest-free financial system, 296 role, 112–114 liquidity enhancement, 278 third-party guarantees, 4, 103, 116, price setting, ethics, 301–302 principles, 3 122, 218 stability, global financial risk lesson, Kaffah, 176–177, 353 Kauniyah, 170, 353 296 – 298 Khata’, 353 Syari’ah governance, evolution, Khattab, Umar bin, 178 Khida’, 174 177 – 179 Khiyar, 155, 175, 353 Islamic financing contracts, King Faisal, 11 Kuwait Finance House, 12, 278 characteristics, 108–110 Kuwait Finance House Research Islamic Fiqh Academy, moral issues (KFHR), 291 (publications), 14 Kuwait, Syari’ah governance, 190 Islamic index, usage, 306 Islamic Interbank Money Market Labor Ijarah pricing, 309–311 (IIMM), 320 service, leasing, 309 Islamic interbank money market Labor supply curve (SL), 310 (KL-LIBOR), 276, 306 Islamic mutual fund, 291–292, 330 Islamic mutual funds, 286 Islamic operational risk, measurement, 160 – 166

Index 395 La darara wa la dirara, 353 definition/coverage, 267–270 Land certificate, 219–220 determinants, 270 Large-capacity database, usage, 65 generation, 25–26 Lawsuit, possibility, 18–19 impact, 345 Lease-based contract, 18 increase, 148–149 Lease payment, delay, 159 measurement, 272–274 Leasing, 353 mitigation, 274–281 Legal documents approach, 184 reduction, 276 Legal instrument, 186 sources, 270 Legal risk, 18–19, 148, 157–158, 160 urgency, 264–265 Lehman Brothers, failure, 194 Liquidity risk management, 276 Letter of credit, 138 hurdles, 279–280 Leverage ratio, 35, 67, 71, 95t IFSB principles, 281 Liabilities process, 273f Li-tabarru’ (pure-assistance contract), 115 composition, 81 Li tabarru’ (social-based contracts), 114 equity, syirkah, 84–86 Li-tabarru’ contract, 353 profit-sharing principle, 90–91 Li-tijari contract, contrast, 3–4 Line of business, Islamic bank usage, 162 pure debt, 7 Liquid funds, sufficiency, 89 Li tijari (commercial-based contracts), 114 Liquidity Li-tijari contracts, 353 BCBS measurement, 348 Li-tabarru’ contract, contrast, 3–4 buffer, 353 Loans, channeling, 25–26 complexity, 267 London Interbank Offered Rate (LIBOR), cost, bank payment, 268 creation function, banks (relationship), 306, 314 Longer-term structural ratio, 354 269 Long-Term Capital Management (LTCM), crises, 265–267 defining, 82–83 failure/crisis, 37, 264, 336 dimension, 268–269 Long-term financing, 80 excess, 296 Long-term infrastructure projects, 291 impact, 272 Loss-absorbing capital, 223 management, enhancement, 41 Loss distribution, 252f measurement, 89, 273–274 mismatch, 233 deviation (variance), calculation, 251 necessity, 267–268 estimation, 166 problems, 265, 279 Loss event, 57, 165 program, 353 Loss limit policy, 255 ratio, 93t, 272–273 Lump sum, 27–28, 354 shortage, cases, 276–277 standard, maintenance, 278–279 Maal al-mutaqawwam, 354 strategy, 280–281 Macroenvironment, changes, 203 surprise, generation, 278–279 Madhhab (schools), 333–334 Liquidity coverage ratio (LCR), 239, Magashid syari’ah approach, 184 Maintenance costs, 126 279, 354 Malaysia, Syari’ah governance, Liquidity Management Center (LMC), 188–190, 189f 277–278, 320 Mapping process, 163 Liquidity risk, 18, 108–109, 264, 324 Maqashid syari’ah, 170–171, 177, 354 Maquashid syari’ah (purposes), 177 control, 280–281

396 INDEX Marked-to-model method, 249 Medium-term financing, needs, 256 Marketable derivative instruments, Micro-banking approach, 307 Microfinancing, 318 292 – 293 Micro, small and medium enterprise Market discipline, 39, 320 Market interest rate, 305–306, 314 (MSME), 225 Market movement, group sensitivity, Minimum capital adequacy (Basel II 228 – 229 pillar I), 38 Market price, measurement, 140–141 Minimum capital adequacy ratio, Market risk, 18, 108, 257 calculation, 69 calculation, 250 Minimum capital charge, 151–152 division, 232 Minimum capital ratio, 39 exposure, 258f Minimum capital requirements, key factors, 247–248 management, 248–250, 254 calculation, 66–71 manifestation, 238 Minority interest, 69 measurement, flow, 243f Mispricing, occurrence, 107–108 measurement problems, 248 Mitigation, 114, 354 mitigations, implementation, 256–263 Monetary Authority of Singapore occurrence, 259 origination, 246 (MAS), 231 profile, identification, 239–244 Money, 7 sensitivity, 233–234 sources, 246–247 capital, consideration, 6–7 urgency, 233–234 creation, 266 Market risk-weighted asset, formation, issuance, 266 Moral hazard, 315, 354 242 impact, 318 Marking to model, usage, 249 possibility, avoidance, 115, 117 Mark-to-market approaches (market risk presence, 214 risk, 112 management exposure calculation), Mortgage-backed securities, 354 249 – 250 Mu’ajjal, 117 Mark-to-model approaches (market risk sale, margin size (determination), 8 management exposure calculation), Mu’ajjal contracts, 8 249 – 250 basis, 84 Mark-up (price) risk, 236–237 time value of money, 304–305 Maslahah, 293, 316, 354 Mu’amalah Maturity activities, 172 class, offset, 247 contract examples, 4 gap, calculation, 274 prohibitions, 172–175 mismatch, 300 transaction, 9 period, 68 usage, 172 profiles, 136 Mu’awadhah, 354 Maturity/liquidity-base approach, 84 Mubah, 172 Maysir, 354 Mudharabah, 79, 354 activity, 173–174 capital, 219 gambling, 5, 62, 108, 172–174, 315 deposits, usage, 272 prohibition, 339 equity-based financing, 91 speculation, 109 investment contracts, 10 Mazhab, 354 investment risk, impact, 216–220 model (profit-loss sharing), 345–346

Index 397 partnership, 81 profit sharing, determination, 313f pricing, 311–312 Musyarakah investment, 221 profit/loss sharing-based contracts, 72 profit share determinants, 312f contracts, 10 profit-sharing mechanisms, Musyarakah mutanaqishah, 355 Mutasyabihat verses, 170 implementation, 72–73 Mutual payment guarantees, restriction, absence, 101 Mudharabah contract, 206–207, 219f elimination, 92 Mudharabah interbank investment Muzara’ah, 355 Myt-Ghamr Bank, 11 (MII), 306 Mudharabah muqayyadah, 85, 108, 354 Nafs recognition, 3 Mudharabah mutlaqah, 354 Nasi’ah usury, 355 National Syari’ah board, 14, 181–182 Mudharabah muqayyadah, contrast, Net financing margin, 97t 326 – 327 Net impaired financing ratio, 97t Net Salam/Istishna’ commodity position unrestricted investment accounts, 84 – 85 (overview), 262–263 Net special commission, 97t Mudharat, 171, 287, 293 Net stable funding ratio (NSFR), 240 Mudharib, 215, 354 Netting method, 253–254 Mugharasah, 354 Nisbah, 355 Muhkamat verses, 170 Muhtasib (responsibility), 178 agreed-upon ratio, 10 Mukharabah, 354 proportion, 5–6, 217 Multilicense system, 321–322 Non-cash deposits machine (CDM), 202 Multiplier effect, 5 Nondepository financial institution, 198, Murabahah, 354 200 contracts, 28, 156–157 Non-interest banking facilities, financing, 90, 109 rate-of-return risk, 258–259 conventional interest rate (negative risk-weight, 142 relationship), 306 sale-based contracts, 72 Nonperforming assets, 132–133 sale-repurchase contract, 33 Nonsystematic market risk, 232 scheme, market risk, 259f No risk, no gain, 337 Murabahah bil wakalah scheme, 325 Murabahah li al-amir bi al-syira’, 354 Objectivity (information quality Murabahah purchase order (MPO), 117 criterion), 77 contract, 118f, 155 default risk factors, mitigation methods, Off-balance sheet, 269, 355 accounts, 43 119t –120t financing, inherent risks, 102 Musaqat, 4, 355 items, credit conversion factor, 143t Musawamab, 355 Muslim Pilgrims Savings Corporation, Off-balance sheet activities, 138 earnings, recordation, 102 establishment, 12 risk on-risk off characteristics, 102–103 Musyarakah, 79, 355 risk weights, 143 contract, investment risk (impact), 220 On-balance sheet, 43, 355 equity-based financing, 91 Operating efficiency, 98t Musyarakah-based business, 28 Operating expenses to total assets Musyarakah-based Sukuk, 68 profit/loss sharing-based contracts, 72 ratio, 99t Operating expense to income ratio, 98t

398 INDEX Operating income to assets ratio, 98t, 99t occurrence, 157, 159, 160 Operating lease, 125, 126f Peraturan Bank Indonesia (PBI), 231 Operating profit, 219–220 Persistence analysis, 88–89 Operational costs, 126 Philippine Amanah Bank, establishment, Operational expenses, control, 91–92 Operational risk, 18, 108–109, 345 12 Philosophy, building, 22 Basel III statement, 195–196 Plan-do-check-act (PDCA) principle, 50 capital charge, calculation, 162, 163 Portfolio cause, 145 challenge, 153–154 diversification, 84 coverage, 152f risk, 135, 328 direct loss types, 151t value at risk, 242 factors, identification, 149–155 Post profit sharing audit, 225 framework, 167 Potential capital, 6–7 frequency/severity, 153f Predetermined fixed interest, 301 identification, 149f, 160 Prediction capability, 76 impact, 157–158 Pre-orders, 78 internal source, 150 Price (mark-up) risk, 236–237 loss, risk (impact), 145–146 Price (mark-up) setting, ethics, 301–302 management system, development, Price-setting process, 108 Price variance, 248 166 – 167 Pricing model measurement, 65 time value of money, 302–305 occurrence, 144, 158, 161f transparency/fairness, 300–301 scope, 146–149 Probability, determination, 216 size/complexity, 144 Procyclicality, 355 taxonomy, 154f Production process, 303, 304 types, 152, 156–158 Productivity-based pricing model, Operational risk value at risk 309 – 314 (OpVaR), 166 Product/marketing innovations, Opportunity cost, 355 Opportunity momentum, avoidance, 236 impact, 102 Organizational culture, building, 22 Products, price setting, 347–348 Organizational structure, 22–24, 63–64 Profitability Organization-based risk mapping, 24–26 Organization of Islamic Cooperation ratio, 90, 91, 96t –97t risk, 355 (OIC), 12, 14 Profit and loss-sharing (PLS) modes, 234 Overnight rate, 314 Profit and loss-sharing (PLS) schemes, 81 Owner equity, statement, 81–82 Profit distribution management, Ownership, transfer, 127–128 regulations, 230–231 Pakistan State Bank of Pakistan (SBP), 190 Profit equalization reserve (PER), Pakistan, Syari’ah governance, 190 Parallel salam (performing), 248 218–219, 227–230 Past-due receivables, risk weight, 142t calculation, 230–231 Peer group analysis, 92 establishment, 326 Pension effect, occurrence, 136 Profit expectation, 308 Pension fund assets/liabilities, 69 Profit-loss share, 19–20 People risk, 146–147, 156 Profit-loss sharing, 45–46 contract, 20, 215 interest-based return, contrast, 6–8 mechanisms, 213

Index 399 model, implementation (bank Quantitative Impact Study, 163 obligation), 299–300 Quasi-fixed income securities, process, 108 changes, 232 Syirkah contracts, 162 Quasi-fixed rate-of-return scheme, Profit/loss sharing-based contracts, 72 Profit ratios, 332 application, 346 Profit sharing Qur’an, 325 mechanisms, 72–73, 214 schemes, risks, 325–326 ethical laws, 73 system, application, 10 verses, 295 Profit sharing investment account (PSIA), Qurudh usury, 355 162, 219 Rahimahullahu, 171 account, holders, 227–229 Rahn, 355 bounded/unbounded types, 236 contract, guarantee (prohibition), 220 funds, 225 equity capital, consideration, 222 guarantees, 108 inclusion, effect, 145, 223 role, 113–114 management, 228 Rahn collaterals, 103, 110–111, 121–122 Profit to equity issuance, 224–225 management, 329 Profit to expense ratio, 97t request, 113 Profit to total assets ratio, 97t usage, 218 Project Management Institute (PMI), 49 Rasulullah shalallahu’alaihi wassalam, Property individual ownership, 172 177 volatility, 339 Rate of return, 136 Provision limit policy, 254 Prudential regulations, AAOIFI technical risk, 19–20, 316 Rate-of-return, 275 guidelines, 73 Public trust, loss, 336 availability, 126 Purchasing power stability, 75–76 risk, 26, 46, 234–237, 326, 346 Rating agency, bank development, 128 Qabdhu, 355 Real assets, price (increase), 236 Qadhi, 114–115, 355 Real estate sukuk, 324 Qardh, 355 Real goods/services, Islamic bank debt, 4, 8, 107 (dealings), 10–11 funds, zero cost, 86 Real-sector return approach, 308–309 lending, 72 Rebalancing, 355 loan, 4, 8, 115 Regulatory agenda, future, 333–335 Qardhul hasan, 115–117, 115f Regulatory failure, 338 default risk factors, mitigation methods, Reinvestment risk, 316, 355 Relevance (information quality 116t –117t pure debt, 107 criterion), 76 short-term contract, usage, 115, 117 Reliability (information quality criterion), Qard-hulhasan (social-oriented loan 76, 81 contracts), 207 Rent/lease (Ijarah), 4 Qatar, Syari’ah governance, 192 Repayment defaults, 61 Qimar (activity), 173–174 Replacement cost approach, 306–307 Q ratio, 307 Repurchase agreement (repo), 246, 277 – 278 Reputational risk, 19, 148–149 Reputation risk, 46, 316 Reserve capital, increase, 348

400 INDEX Reserved capital, minimum organization-based risk mapping, requirement, 134 24 – 26 Retained earnings, 68 owner philosophy, 347 Re-takaful, 355 premium, 299 Return, 212–213 presence, 328 profile, 103, 356 benchmark, 24 register, 54, 55f, 356 distribution, 301 reporting, 26 Return on assets, 96t resolution, Return on deposits, 96t Return on equity, 96t technology/personnel/resources Revenue, gain, 187 (usage), 52 Reverse CMT, 71 return, trade-off, 27–28, 252 Riba, 355 review process, 62 abolition, 5, 6 risk-adjusted performance, 356 concept, 331 risk-based CAR, leverage ratio prohibition, 339 (impact), 67 usury, 6, 62, 172–173 risk-based financing limit, 133 Riba buyu’, 355 risk-based pricing, 356 Risk, 355 risk-free assets, usage, 7–8 AAOIFI categorization, 20 risk-return profile, 23 absorption hypothesis, 269 risk-return trade-off, 356 analysis, 63, 72–74 risk-sharing practice, 275 appetite, 54f, 346, 356 risk-sharing services, 205 risk-weighted individual assets, external determination, 52–53 rating assessment (basis), 140t notion, 49–50 sensitivity, 165 awareness, urgency, 144–145 source, mapping, 25–26 calculation, 245, 251 target, 53 charter, 346 tolerance, 53, 356 contribution, 134f Risk-adjusted performance model coverage, analysis, 39 (RAPM), 253 distribution, 134f, 288 Risk-adjusted return on capital (RAROC), drivers, identification, 240, 242 251–253, 319, 355 effects, calculation, 250 calculation, 252f evaluation, criteria/assumptions, 52 Islamic bank usage, 253 eventuality, 48 measurement, 253 forms, 216–230 model, utilization, 278 identification, 28, 51, 56–57 Risk management, 44, 161–162 impact, 210–211 aim, 47 information, imperfection, 17 application, 108 limit, 53, 356 bank effort, 57 mapping, business line/unit function context determination phase, measures, 51 – 52 basis, 25f evolution, 49f measurement, 16, 53–55 financing, urgency, 108–109 focus, 20, 22 models, 26, 66 framework, 50–52, 51f requirements, 253 history, 33 minimization, 101 occurrence, 19

Index 401 IFSB framework, 46 cancellation, 305 implementation, 46, 315–317 commodity risk, 259–261 importance, 28–29 goods, conversion, 118, 121 Islamic bank, relationship, 9 operational risks, 157–158 methods, usage, 20, 22 price, usage, 7 organizational structure, 63–64 risk factors, mitigation methods, policy, documentation, 62–63 principles, usage, 20, 22 123t –124t solution, 239 scheme, 260 stages, 20–27 time value of money, 304–305 system, 319 Sale (Bay’), 4 task force, Sale-based contracts, 72 Savings accounts, deposits (amount), 88 characteristics/responsibilities, 64 Scenario analysis, 356 Risk management charter (RMC), 50–51 Securitization, 69, 256–257 Risk management process, 22 Severity, 58, 356 Shadaqah, 9–10, 113 analysis criteria, development, 52 Shadow bank, 198 flow, 52f Shadow banking institution, 200 planning, 51 Shadow usury, 256 stakeholder, 52 Shahibul maal, 356 Risk matrix (matrices), 57–61, 59f, 356 capital owner, 210 composition, 58 guarantee, 87 construction, 27f reliance, 216–217 development, 57–59 risk-return linearity, benefits, 215 time horizon, 60–61 Shahih, 173 RiskMetricTM model, 356 Shahih hadith, 295 Risk mitigation, 26–27, 101–102, Shareholder capital withdrawal, risk (increase), 216 – 230 measures, variation, 61–62 148 – 159 methods, 199t retained earnings, 229 process, 61–62 Shareholder’s value added (SVA) technology/personnel/resources, model, 253 usage, 52 Shirkah contracts, investment risk tool, defining, 346–347 Risk-return linearity, benefits, 215 (mitigation process), 225 Risk-return trade-off, 107–108 Short-term assets, 84 Risk-weighted assets (RWAs), 70 Short-term financing, 80, 91, 256 calculation, 222–223 Short-term funding, source, 273 increase, determination, 245–246 Short-term liquidity, 90–91, 327, 340 standardized approach, 139–143 Silver value, 24, 41, 67 ’Rjrah, 357 foreign currency treatment, 261 gold exchange, 263 Salam, 356 Single banking system, dual banking parallel contracts, effect, 260f performing, 248 system (contrast), 15–16 pre-ordering, 79 Small and medium enterprise (SME) sale-based contracts, 72 owners, 200 Salam contracts, 8, 121f, 157–158, Smoothing techniques, 229 239 – 240 Social justice, promotion, 318–319 Solvency ratio, 90, 91, 93t –94t

402 INDEX Southeast Asian crisis, 37, 345 Supreme Syari’ah Council, 192 Speculation, elements (removal), 316 Swap, 357 Speculative risk, 246–247, 297 Syaikh, 357 Stakeholder, 203–204, 356 Sya’ir (grain), 172 Standardization regulatory/supervisory Syarah, 73, 357 Syari’ah framework, 334 Standardized approach (SA), 161, advisory board, 179–181 auditing methods, 184–185 163 – 164 banking, share, 204–205 Standardized measurement method, 356 board, 178–179 Stocks supervisory framework, categorization, 258 strengthening, 334–335 investment, 69 pay-off possibilities, 288 contractual requirements, 74 surplus, 68 financial services, 205 Stock securities, comparison, 290t laws, violation (avoidance), 33 Strategic risk, 19, 194–196 noncompliance risk, 146, 187 determinants, 196–204 partnership, 210 issues, 204–208 principles, 12–13, 19, 44, 170–172 mitigation, 196–204 taxonomy, 197f information, 320 Strategy formulation, 200 Islamic bank noncompliance, risk, 201t Stress testing, 356 impact, 146 Stress-testing, necessity, 251 presence, 214 Structure-conduct-performance model, prohibition, 287–288 purpose, 183 308 requirements, fulfillment, 16 Subprime mortgage, 297, 356 standards, 13 supervision board, 334–335 crisis (2008– 2009), 302, 335, 345 supervisor board, members Substitution (integrity/independence), 182–183 marginal rates, 301 Supervisory Board, 13, 14, 180 products, emergence, 198–200 Syari’ah-based products, 325, 357 Sukuk, 356 Syari’ah-compatible financial asset value, 291 income, 236 transactions, 332 issuance, 278 Syari’ah-compliant financial contract market, 247–248, 291 price, 18 models, selection, 81 publication, 256 Syari’ah-compliant hedging, 238 structuring, 71 transactions, 294 absence, 234 types, 256 contracts, 71 Sunatullah, 356 Syari’ah-compliant product, 327, 357 Sunna, 73, 356 Syari’ah Advisory Council (SAC), Super-micro sukuk product, creation, 324 188, 328 Super-regulatory institutes, absence, Syari’ah compliance, 15, 72, 75, 168 absence, 213 318 – 319 audit, 179–183 Supervision (Basel II pillar II), 38–39 integration, 176–177 Supervisory haircuts, 141 review instrument, 186 Syari’ah compliance risk, 34, 147–148, 168

Index 403 attachment, 156 Takaful, 28, 357 identification process, 183–187 insurance, 61 inclusion, 144 territory, 323–324 occurrence, 157–159 risk management/mitigation, 187 Tauliyah, 357 Syari’ah governance, 188–193 Tawarruq, 71, 357 comparison, 193t Technology development, 60–61, 102 evolution, 178f Technology risk, 147, 158 Syirkah, 357 Tenor, 357 business, partnering, 4 Third-party funds, 90, 269 partnership, 209–210 profit, bank share, 230 collection, 108 profit-sharing arrangement, 80 composition, 82 Syirkah-based contracts, 209–210 liabilities, management, 33 Third-party guarantees, 323 investment risk (Basel III Third-party transaction risk, 28 recognition), 221–223 Three-pillar approach, 37 Tier 1 capital, 67–68, 82 presence, 220 Tier 2 capital, 68–69, 82, 244 usage, 225–226 Tier 3 capital, 240, 244 Syirkah-based investments, Tijari (profit motive), 27 Timeliness, 76 rate-of-return risk, 215–216 Time value of money, 7, 303 Syirkah contracts, 159 Tobin’s Q, concept, 306–307 Too-big-to-fail, 112, 196 equity price risk, 257–258 Too-connected-to-fail, 297, 323, 335 investment risk Too-many-to-fail, 112 Top-down banking approaches, 22, 23f identification, 223–224 Trade mitigation tools, 224–230 financing, 110 Systematic market risk, 232 risk, trade-off, 27–28 Systematic risk, 340–341, 357 Trading System failure, 165 book, 239–240 Systemic national collapse, risk, 34 schemes, categories, 78 Systemic risk, 357 Transaction exposure, 262 analysis, 336 Transaction risk exposure, cause, 238 anticipation, 320–321, 335–341 Transactions, risk-return profile, 23 concern, 22 Translation exposure, 262 measurement, methods, 340–341 Transparency, 92, 102–103 network model, 340–341 Treasury (fund management), 357 understanding, 336 Twitter risk, 148–149 Ta’ala, 17, 170–171 Ujrah, 275, 314 Ta’awun, 357 contracts, 324 Tabarru’ lease/rent, 304 remuneration agreement, 125 contracts, 27 funds, 225 Ulama, 173, 179 Tadlis, 357 ’Ulama, 357 fraud, 17, 108, 172, 175 Ummah, 357 presence, Islamic prohibition, 17 swindling, 5 Taghrir, 357 Tail event, 242

404 INDEX Unbounded profit sharing investment guarantee, 242 account, 235 measurement, 253 method, usage, 247 Uncertainty, 17 risk calculation method, economic manifestations, 57 removal, 316 basis, 241 risk, 216 Value of average product of labor (VAPL), Understandability (information quality value, 309–311 criterion), 77 Value of marginal product (VMPL), Undiversified risk, 357 310 – 311 Unexpected loss, 166 Volland, Emmanuel, 339 Uniformity (information quality Wa’ad, 127–128, 358 criterion), 76 Wadhiah entrustment, 4 Unique risk, 357 United Arab Emirates, Syari’ah Wadhiah-based product, 9 Wadhiah safekeeping, 72, 107 governance, 192 Wadhiah yad amanah, 358 Universal complementarity, 5, 301 Wadhiah yad dhamanah, 358 Unrealized gains/losses, 69 Wadiah yad amanah (safekeeping), 107 Unsystematic risk, 357 Wadiah yad dhamanah Unsystemic risk, 357 Usufruct, 11, 357 debt, 107 Usury, 286, 357 safekeeping, 107 Wad’iyah, 358 elimination, principle, 301 Wages, payment, 309–310 Islamic ban, 7 Wakalah, 358 nasi’ah usury, 355 agency, 72–73, 81, 107, 125 prohibition, 169, 172, 302–303, 339 qurudh usury, 355 contract, 117–118, 211 Riba, 172–173 representation, 4 Usury-based transactions, allowance, 222 Wakalah-based products, 329–330 Utility/benefit (information quality Wakalah bil ujrah, 125, 358 brokerage, characteristics, 84 criterion), 76 Wealth transfer, Mu’amalah Utsmani, Syaikh Muhammad Taqi, 168 (usage), 172 Vagueness (Gharar), 174–175 Write downs, 154–155 Value at Risk (VaR), 63, 250–251, Zakat, 9, 69 319, 357 Zero-sum game, 215, 358 calculation, basis, 251