Islamic banks needed to manage the risks in the financial system ahead of any possible crisis or downturn, business advisory firm PricewaterhouseCoopers (PwC) warned at the weekend.
Mohammad Faiz Azmi, global leader of PwC’s Islamic finance team, said: "Risk management is an issue which cannot be ignored by any financial institution, but Islamic banks in particular need to establish risk management credibility as they aspire to move into the mainstream of the financial system."
Trading in derivatives and speculative investment is forbidden in Islamic banking, as sharia law requires that all transactions be backed by tangible assets. By not associating themselves with forbidden transactions such as these, Islamic banks were not exposed to the same risks — which were cited as having resulted in the global economic recession — as their non-Islamic counterparts.
Despite weathering the storm, those banking institutions face their own challenges, ranging from real estate risk to operational, liquidity, fiduciary and reputational risk.
According to a recent report issued by PwC on managing Islamic banking risks, these banks tend to have concentrations of cash and of long-term assets, as a result of a shortage of sharia -compliant money market instruments, which creates significant liquidity gaps.
Because of this shortage, "Islamic banks may also find it difficult to generate enough floating-rate assets to offset their floating-rate liabilities, and they lack the interest rate hedging instruments available to conventional banks".
However, the introduction of sharia - compliant repurchase transactions and moves to generate even more sharia -compliant instruments would increase liquidity, said Mr Azmi.
Until that market emerged, banks should thoroughly monitor the risks associated with their liquidity, assets, liabilities and interest rates, he said.
It was common among Islamic banks to have a high exposure to real estate and many Islamic products might be based on real estate assets while actually exposing the bank to counter-party risk.
"In addition to ensuring you have the right skill sets to deal with specialised assets, you also need to clearly communicate these risks and be transparent with stakeholders, so that banks can better manage their risks."
Another development was that there was an increasing focus on whether Islamic products complied with sharia .
This had led to new guidelines and standards being developed that dealt with matters such as the conduct of sharia scholars; the need for a more formalised sharia governance framework; and the importance of independent reviews such as sharia audits.
The sharia audit in particular had disclosed more operational problems, some of which had resulted in financial loss.
"These global developments are important to the Islamic finance industry in Africa and should be addressed as we develop our own Islamic banks," said Zuhid Abrahms, a director in financial services at PwC.
source: BusinessDay South Africa