Islamic banks face specific categories of financial risks compared to conventional banks, says an industry report.
According to research by Moody’s Investors Services the most critical risks are entanglement and displaced commercial risks.
“The first one reflects the fact that each Sharia-compliant transaction tends to include credit, market and operational risks, all of which we need to understand to better fine-tune our analysis,” the report by the financial research and analysis group said.
“Islamic banks are improving the way they identify, measure, control and mitigate those risks, as balance-sheet and capital management is becoming a critical field where investments in technology and human talent are increasing”
“Beyond financial risks, Islamic banks are also subject to other forms of risks, specific to their business models.”
It argues these are reputation risks and the risks of being perceived as not sufficiently Sharia-compliant.
“This has a powerful disciplinary effect, but could become harmful should the market perceive any form of incompliance,” it adds.
The report identifies five possible weaknesses in these institutions.
These include the range of asset classes found in Islamic banks and the relatively weak position of investment account holders.
“The importance of the Sharia supervisory board and the bank’s ability to provide the board with adequate information as well as abide by its rulings, is also an issue as is rate-of-return risk and new operational risks.
“Notwithstanding that the Islamic Financial Services Board’s endeavour to provide the Islamic banking industry with a set of guidelines towards best-practice risk management, we believe that a number of additional risk issues deserve further examination,” the report adds.
“This view stems from Islamic financial institution’s relatively short track record – modern Islamic banking has been in existence for only three decades and many sukuk products are less than a decade old – and the fact that most Islamic banks are active in the developing world where transparency, corporate governance and risk management at large are still works in progress.
“The other problem it identifies is the shortage of skilled risk management professionals familiar enough with the Sharia-compliant banking universe.”