Friday, March 13, 2009

Islamic finance and risk management, an extra layer of scrutiny

Roger Smee, a former soccer player in the U.K. who is now a businessman involved with Islamic finance,is quoted describing the benefits from Islamic finance in an article in the Times:
Instead of looking down on what we are quick to reject as cumbersome legal restrictions, we should take a page out of the Middle East’s book and use the principles of Sharia to begin building real and sustainable economies.”
This alludes to the primary benefit from Islamic finance versus conventional finance: the restrictions created by the need for Shari'ah-compliance serve as an extra layer of risk management. It is not necessarily the fact that it is a faith-based method of finance, but the specific rules that are followed that provide Islamic finance with its relative resiliency in times of financial turmoil. Sure, the benefit in some cases is offset by the lack of access to inter-bank lending as I have stated before as well as concentration in certain sectors, but the real key is in how the rules are applied.

In addition to conventional risk management and credit analysis to determine suitability, Islamic banks are forced to focus to a greater extent on the actual structure of the transaction and has a quasi-independent board (the Shari'ah board) who do this. They look at the structure to decide whether it is excessively speculative or onerous on each party in order to come to a decision on the product's Shari'ah-compliance. Although in the retail Islamic banking business, this is not done in any case, there are internal Shari'ah auditors who review the execution of the transactions to ensure they follow the strictures set down by the scholars.

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1 comment:

Anonymous said...

good article