1. Risk Issues In Islamic Banking
International Islamic Finance Forum March 2002 : Dusit Hotel, Dubai, UAE
Warren Edwardes,
ceo, Delphi Risk Management Limited e: w:
Warren Edwardes

2. Delphi’s website contains:
articles on Islamic banking on: dc3.co.uk/ibnews
The full speech, on Risk Issues and Liquidity Management within Islamic Finance Institutes is on: dc3.co.uk/islamicfinancerisk ppt
Warren Edwardes

3. some actions can protect the same actions can destroy
financial risk
some actions can protect
the same actions can destroy
Warren Edwardes

4. Appendix 1 (50 Risk types): Appendix 4 (Islamic banking)
from the book: "Key Financial Instruments: understanding and innovating in the world of derivatives"
Appendix 1 (50 Risk types):
dc3.co.uk/risks.htm
Appendix 4 (Islamic banking)
dc3.co.uk/islamicbanking.htm
Does Islamic banking risk differ from Conventional banking risk?
Not different - just a special case
Warren Edwardes

5. A check-list of 50 banking risk types
To put it simply and directly,
if the bosses do not or cannot understand both the risks and rewards in their products,
their firm should not be in the business. -
William J. McDonough, President, Federal Reserve Bank of New York
Warren Edwardes

6. banking risk types - 1-4 Acquisition Risk Careless Error Risk
Different cultures between banks “consolidating”
Careless Error Risk
Human error should be forgiven. But this is not covered by law
Competitive Risk 
LIBOR / KLIBOR / EIBOR determine competitors returns
Commodity Risk
If you take delivery can the commodity price be managed? 
Warren Edwardes

7. banking risk types - 5-8 Communication Risk Country Risk Credit Risk
Al Wadiah or Musharaka ? Sudan case
Define terms clearly
Country Risk 
much of Islamic banking is carried out in emerging markets. Riskier?
Credit Risk
Not loans. Not IOUs. So equity not loan risk
Cultural Risk 
Difference between Gulf and Malaysia. Heard yesterday about the four schools in Fiqh Islam
Warren Edwardes

8. Currency Transaction Risk
banking risk types – 9-12
Currency Transaction Risk
No use of derivatives permitted. Cannot hedge exchange rate for purchases
Currency Translation Risk
Balance sheet value of dollar assets or liabilities fluctuate
Currency Economic Risk
Again no hedging permitted. So how can Proton compete with Hyundai cars if the KRW depreciates
Customer Satisfaction Risk
If a bank pays no dividends despite making profits customers will get angry 
Warren Edwardes

9. Disaster Recovery Risk Economic Activity Risk
banking risk types
Disaster Recovery Risk
If a terrorist or earthquake strikes can you cope?
Economic Activity Risk
Overheads are fixed. Post Sep 11 downturn is perhaps economic downturn and not money laundering related
Energy Price Risk 
Most Islamic countries’ economies are linked to the oil price
Environment Risk
Are environment unfriendly policies haram?
Warren Edwardes

10. banking risk types - 17-20 Equity Market Risk Fraud (banker) Risk
Islamic banking is ideally profit and loss sharing. This is venture capital or equity investment
Fraud (banker) Risk
Transparency is required. Avoid the risk of misinterpretation
Fraud (customer) Risk
If an investor loses money will he seek redress? Of course if he wins he will not
Fraud (staff) Risk
Haram for lenders to seek material benefit. BCCI was not an Islamic bank but fraud could occur in Islamic banks
Warren Edwardes

11. banking risk types - 21-24 Image / PR Risk Information Risk
Something deemed hallal could be deemed haram. Sep 11 was bad PR
Information Risk 
Lack of transparency in accounts in many Islamic countries
Inflation Risk 
The securitised asset increases in value but not the repayment amount which being a cash amount depreciates
Interest rate Risk 
This is not a closed economy. If interest rates rise sharply deposits will flow out
Warren Edwardes

12. Interaction Risk Language Risk Legal Risk banking risk types - 25-27
Same as correlation. Sep 11 had an effect
Language Risk 
Arabic, English, Malay, Indonesian, Urdu? Same word can have different meanings. Like Al Wadiah
Legal Risk 
UK, Malaysian, .. Is the bank / customer permitted to carry out such business. Ultra Vires issue
Warren Edwardes

13. banking risk types - 28-30 Liquidity Risk Morbidity Risk
Major problem for Islamic banking is the absence of a developed Islamic money market.
about managing confidence and the liability side.
About managing diversification.
Morbidity Risk
No different from conventional banking. What happens if there is an outbreak of dengue or Anthrax? 
Mortality Risk 
Do you have offices in a tall building? Would you survive major loss through fire?
Warren Edwardes

14. Performance Measurement Risk
banking risk types
Operational Risk
Are strong procedural systems in place? Really everything other than market risks
Performance Measurement Risk 
Most measures of performance are crude and slavish adherence to rules can lead to poor real performance
Political Risk 
Seizure of assets post Sep 11; boycotts
Competence / Understanding 
Are the latest products really understood by the banks’ senior management? By the customers?
Warren Edwardes

15. Concentration of assets Risk
banking risk types
Concentration of assets Risk
A problem for Islamic funds. No tobacco, banking and alcohol stocks can lead to heavy weighting in property and technology
Concentration of liabilities Risk
Do you have enough investors or do you depend on one or two?
Concentration of business type Risk
Financial supermarket or nimble niche player are both fine. But can you reinvent yourself if markets change?
Convertibility Risk
Deliverability risk under exchange controls
Warren Edwardes

16. Property (Real Estate) Risk Rating Agency Risk
banking risk types
Property (Real Estate) Risk 
Would asset backing be sufficient in times of a property crash?
Rating Agency Risk 
A downgrading or even credit watch can impact on liquidity and the entire business. Investment grade bonds do not default. They become Junk and then default.
Regulatory Risk 
A firm operating globally will face different rules
Religious Risk 
A Hallal product may later be deemed Haram. Zero coupon bonds were Hallal
Warren Edwardes

17. banking risk types - 43-46 Resignation Risk Settlement Risk
Over dependence on one person’s skills and contacts?
Settlement Risk 
If there is no escrow account there is settlement risk on Murabaha and BBA
Systemic Risk 
Financial instability is contagious. Financial systems are closely inter-linked
Tax Risk 
Do the sale and repurchase transactions face purchase tax? Income tax or capital gains tax treatment?
Warren Edwardes

18. banking risk types – 47-49 Technological Risk Transport Risk
Are your fax confirmations going to your customer or a competitor?
Transport Risk 
traffic jams may have led to cancelled meetings which may never be rearranged
Weather Risk 
Could you hedge against the weather? KL’s 1998 smog and Kuwait’s burning oil fields probably had an adverse impact on employees health.
Weather derivatives are being traded but probably Haram. Weather Takaful?
Warren Edwardes

19. It’s impossible to take an unnecessary risk.
banking risk types – 50
Zero Risk
It’s impossible to take an unnecessary risk.
because you only find out whether a risk was unnecessary
after you’ve taken it
Giovanni Agnelli, President FIAT
Warren Edwardes

20. Particular Islamic banking risk issues
Liquidity – undeveloped money market
Interest rate Risk 
Commodity
Equity risk – fund management or banking?
Operational risk
Religious – Hallal or Haram?
Language Risk - English, Arabic, Malay or Urdu
Warren Edwardes

21. Risk Issues In Islamic Banking
International Islamic Finance Forum March 2002 : Dusit Hotel, Dubai, UAE
Warren Edwardes,
ceo, Delphi Risk Management Limited e: w:
Warren Edwardes