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Islamic Finance has been experiencing double digit growth globally and risk management has not been at the top of the agenda, but if Islamic banks are determined to play a greater role in the financial system they need to manage the risks involved.
With a quarter of the world’s population being Muslim, there is a growing desire by Muslims around the world to have their financial needs met with Shariah compliant solutions. Companies are also looking to diversify their investor base by seeking funding from Shariah-related sources. Islamic Finance in line with conventional finance is experiencing a return to growth post the financial crisis.
“When the going gets tough, the tough get going. So why shouldn’t you toughen up and get to grips with those risks ahead of any possible downturns? By seizing the opportunity, Islamic Banks can also reap the rewards of further growth while times are good,” says Mohammad Faiz Azmi, Global Leader of PwC’s Global Islamic Finance Team. According to PwC, the time to fix the roof is when the sun is shining and Islamic banks should be dusting their ladders off now.
Shariah law, which prevents complex credit trading, was the life jacket for the Islamic banking sector during the global financial crisis. Despite weathering the storm, those institutions face their own challenges, ranging from real estate risk to operational, liquidity, fiduciary and reputational risk.
“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,” says Azmi.
According to a PwC report titled ‘Managing Islamic banking risks’, Islamic banks tend to have concentrations of cash and of long-term assets, as a result of a shortage of Shariah-compliant money market instruments, which creates significant liquidity gaps.
“As a result of the shortage of Shariah-compliant money market instruments, 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 Shariah-compliant repo transactions and moves to generate more shariah compliant instruments will increase liquidity,” adds Azmi.
Until that market emerges, banks should thoroughly monitor the risks associated with their liquidity, assets, liabilities and interest rate.
It’s common among Islamic banks to have a relatively high exposure to real estate and many Islamic products may be based on real estate assets while actually exposing the bank to counterparty risk.
“In addition to ensuring you have the right skill sets to deal with specialized assets, you also need to clearly communicate these risks and be transparent with stakeholders, so that banks can better manage their risks.”
Another development is that there is increasing focus on whether Islamic finance products truly comply with shariah. This has led to new guidelines and standards that deal with matters such as the conduct of shariah scholars, the need for a more formalized shariah governance framework, the importance of independent reviews such as shariah audits and on the skill sets and knowledge of key management in Islamic financial institutions.
Shariah audit in particular has increasingly revealed more and more operational issues, some of which has resulted in financial loss. It is important that Islamic banks continue to monitor and analyse such event loss as it may have implications on the amount of capital they need to hold in accordance with Basel rules.
“These global developments are important to the Islamic finance industry in Africa and should be addressed as we develop our own Islamic banks. PwC can help in the independent review process by conducting shariah audits and also providing recommendations on how to improve the shariah governance framework of financial institutions in South Africa,” says Zuhdi Abrahams, director in financial services at PwC.
PwC has the breadth and depth of talent amongst its Islamic finance and risk management specialists to help clients with challenges in the sector.
“In order to support Islamic finance in Africa, PwC has expanded their list of Islamic centres of excellence to include PwC South Africa. This will allow us to play a significant role in promoting growth of Islamic finance in Africa.” concludes Abrahams.