Professional Documents
Culture Documents
MANAGEMENT
in Islamic Banking and Finance
Shari’a, Legal and Operational Risks
HUMAYON DAR
CHAIRMAN, PRESIDENT & CEO
EDBIZ CORPORATION
© 2014 HUMAYON DAR; A seminar delivered at Qatar Faculty of Islamic Studies on May 13, 2014
INTRODUCTION
K
RWCR = ≥ 8%
A+B–C
where
RWCR = Risk-weighted Capital Requirement
A = Total Risk-weighted Assets [Credit + Market Risks]
B = Operational Risks
C = Risk-weighted Assets Funded by Profit Sharing Investment Accounts
FOCUS ON OPERATIONAL OPERATIONAL RISK IN
ISLAMIC FINANCE
K
RWCR = ≥ 8%
A + B – C – (1- )D – .E
where
RWCR = Risk-weighted Capital Requirement
A = Total Risk-weighted Assets [Credit + Market Risks]
B = Operational Risks
C = Risk-weighted Assets Funded by Profit Sharing Investment Accounts
0≤ ≤1
D = Risk-weighted Assets Funded by Unrestricted Profit Sharing Investment
Accounts
E = Risk-weighted Assets Funded by Restricted Profit Sharing Investment
Accounts
FOCUS ON OPERATIONAL OPERATIONAL RISK IN
ISLAMIC FINANCE
Eligible Capital
RWCR = ≥ 8%
TRWA [Credit + Market Risks] + Operational Risks –
RWA Funded by PSIAs [Credit + Market Risks]
Management Measurement
OPERATIONAL RISK covers any risk that may arise from general and specific
operations of an organisation, and in the present context, banks in general and
Islamic banks and financial institutions in particular.
12.Somehow, your online banking system has a loophole and some online
search engines have started picking up “cache” pages of some of the
customers who view their accounts using a particular internet browser
OPERATIONAL RISKS IN ISLAMIC FINANCIAL
INSTITUTIONS
• If an IFI / Islamic bank does not comply with Shari’a rules and principles, its
transactions must be cancelled and income generated from them shall be
considered as illegitimate
• Recent example:
– Bank Negara Malaysia issued new guidelines on Bai’ ‘Ina in 2012, which
came after the Shari’a guidelines for Islamic banks and Takaful companies,
making it clear that any non-compliance with Shari’a will not only be
considered as illegal but the bank will also have to claw back income from
the non-compliant transactions
OPERATIONAL RISKS IN ISLAMIC FINANCIAL
INSTITUTIONS
• For example, if in an Bai’ ‘Ina transaction, an evidence was found that the
bank staff actually made the two transactions (first sale to the customer and
the second purchase from the customer) inter-linked, even verbally or through
an action, the transaction will be deemed Shari’a con-compliant and the bank
will be asked to claw back all the accrued income from the transaction and
donate it to charity (and possibly face some penalty from the regulator).
• This is certainly a failure in the Shari’a process on part of the personnel, and
hence should be considered as an operational risk.
OPERATIONAL RISKS IN ISLAMIC FINANCIAL
INSTITUTIONS
– Legal risk
– Shari’a risk
– Fiduciary risk
• In 1998, an official of a UAE Islamic bank did not conform to the bank’s
internal credit term
• It cost the bank US$50 million
• This resulted in a one-day run on the bank’s deposits to the tune of US$138
million, representing 7 percent of the bank’s total deposits
Withdrawal Risk
Mudaraba
Musharaka
Istisna’
Salam
Ijara
Murabaha
Operational Risk
OPERATIONAL RISK MANAGEMENT
– Identification
– Measurement
– Monitoring
– Reporting
– Control and
– Mitigation
OPERATIONAL RISK MANAGEMENT:
IDENTIFICATION
•Technology
•Sales
•Documentation
–It is absolutely imperative that all the legal documents used for Islamic
financial products are vetted by competent personnel well-versed in
Shari’a and law
[In a lot of cases, law firms preparing documents for Islamic financial
contracts adpat/amend the templates that they otherwise use for
conventional financial products; this may leave reference to “interest”,
penalty etc unchanged, which may make the contract Shari’a non-
compliant]
–For conventional banks involved in Islamic banking and finance, it is
important that they ensure that the Shari’a documents are executed and a
proper record of the same is maintained, in addition to the legal
documentation required conventionally
OPERATIONAL RISK MANAGEMENT:
MEASUREMENT
•The STA is a more detailed approach that classifies bank activities into eight
business lines:
1. Corporate finance
2. Trading and sales
3. Retail banking
4. Commercial banking
5. Payment and settlements
6. Agency services
7. Asset management
8. Retail brokerage
OPERATIONAL RISK MANAGEMENT: STA
8
KSTA = i=1 i.GIi
where
KSTA = The capital charge under the Standardised Approach
GI = Average annual level of income in the last three years
i = Beta values for each business line
BETA VALUES FOR DIFFERENT BUSINESS LINES
β2 <
β3 <
β4 <
β5 <
β6 <
β7 <
β8 <
BIA AND STA : CRITICISM
– Instead of relating the operational risk to the size of the organisation (gross
income), it might not be a bad idea to look into the management function
deeply to come up with a measure of operational risk.
– For example, a one-man firm (an owner-managed firm) should have less
incidence of operational risk as compared to a firm with multiple personnel
(owners as well as managers).
• Hence, complexity of organisation should be considered as a factor that
may affect the operational risk
– More complex organisations should be more prone to operational
risk
– In complex organisations, both the management and control
functions should be strong to reduce incidence of operational risk
QUANTIFICATION OF OPERANTIONAL RISK:
MANAGEMENT APPROACH
Identification I1 I2 I3 I4 … In
Measurement Me1 Me2 Me3 Me4 … Men
Monitoring Mo1 Mo2 Mo3 Mo4 … Mon
Reporting R1 R2 R3 R4 … Rn
Mitigation Mi1 Mi3 Mi3 Mi4 … Min
Control C1 C2 C3 C4 … Cn
MEASUREMENT OF MANAGEMENT AND CONTROL
FUNCTIONS
B1 B2 B3 … Bn B1 B2 B3 … Bn B1 B2 B3 … Bn B1 B2 B3 … Bn
I11 I12 I13 … I1n I21 I22 I23 … I2n I31 I32 I33 … I3n … In1 In2 In3 … Inn
Me11 Me12 Me13 … Me1n Me21 Me22 Me23 … Me2n Me31 Me32 Me33 … Me3n … Men1 Men2 Men3 … Menn
Mo11 Mo12 Mo13 … Mo1n Mo21 Mo22 Mo23 … Mo2n Mo31 Mo32 Mo33 … Mo3n … Mon1 Mon2 Mon3 … Monn
R11 R12 R13 … R1n R21 R22 R23 … R2n R31 R32 R33 … R3n … Rn1 Rn2 Rn3 … Rnn
Mo11 Mo12 Mo13 … Mo1n Mo21 Mo22 Mi23 … Mi2n Mi31 Mi32 Mi33 … Mi3n … Min1 Min2 Min3 … Minn
C11 C12 C13 … C1n C21 C22 C23 … C2n C31 C32 C33 … C3n … Cn1 Cn2 Cn3 … Cnn
MEASUREMENT OF MANAGEMENT AND CONTROL
FUNCTIONS: CONSTRUCTION OF GRID
where
• The operational risk score should be a component in the bonus formula for
the top management
DISCUSSION POINTS
humayon@humayondar.com
http://www.edbizconsulting.com