Risk Analysis for Islamic Banks

For a long time now, the idea of operating Islamic banking has generated a lot of debate or argument, especially in Nigeria which has different religions. I was therefore excited when I was handed this book by a former boss of mine on his return from a World Bank conference in the United States of America recently. At least, reviewing it will shed more light on the supposed grey areas of Islamic banking.

This text entitled “Risk Analysis for Islamic Banks”, published by the World Bank, is co-authored by Hennie van Greuning and Zamir Iqbal. Iqbal is a principal financial officer with the Quantitative Strategies, Risk and Analytics (QRA) Department of the World Bank Treasury. He earned his Ph.D. in International Finance from the George Washington University, where he also serves as the adjunct faculty of international finance. Iqbal has written extensively in the area of Islamic finance in leading academic journals.

As for Greuning, he is a senior advisor in the World Bank Treasury and has worked as a sector manager for financial sector operations in the Bank. He has had a career as a partner in a major international accounting firm and as chief financial officer in a central bank. Greuning holds doctoral degrees in both Accounting and Economics.

Greuning and Iqbal say over the years, the Islamic Financial Services Board and related organisations have invited them to workshops and conferences, allowing them to learn from the many scholars presenting at those gatherings.

Structre-wise, this text is segmented into four parts of 15 chapters. Part one is generically tagged “principles and key stakeholders”, and covers the first four chapters. Chapter one is entitled “principles and development of Islamic finance”. Here, these authors educate that Islamic finance is a rapidly-growing part of the financial sector in the world. They add that indeed, it is not restricted to Islamic countries and is spreading wherever there is a sizable Muslim community. They disclose that more recently, it has caught the attention of conventional financial markets as well.

Greuning and Iqbal reveal that according to estimates, more than 250 financial institutions in over 45 countries practise some form of Islamic finance, and the industry has been growing at a rate of more than 15 per cent annually for the past five years. The market’s current annual turnover is estimated to be $350 billion, compared with a mere $5 billion in 1985, add these authors.

Greuning and Iqbal stress that whereas the emergence of Islamic banks in global markets is a significant development, it is dwarfed by enormous changes taking place in the conventional banking industry. These authors educate that rapid innovations in financial markets and internationalisation of financial flows have changed the face of conventional banking almost beyond recognition.

In Greuning and Iqbal’s words, “Rapid developments in conventional banking have also influenced the reshaping of Islamic banks and financial institutions. There is a growing realisation among Islamic financial institutions that sustainable growth requires the development of a comprehensive risk management framework geared to their particular situation and requirements.” These authors add that at the same time, policy makers and regulators are taking serious steps to design an efficient corporate governance structure as well as a sound regulatory and supervisory framework to support development of a financial system conducive to Islamic principles.

Chapter two is based on the subject matter of the theory and practice of Islamic financial intermediation. Here, Greuning and Iqbal say financial systems are crucial for the efficient allocation of resources in a modern economy. They add that the landscape of financial systems is determined by the nature of financial intermediation, that is, how the function of intermediation is performed and who intermediates between suppliers and users of the funds.

According to these financial experts, financial intermediation in Islamic history has an established historical record and has made significant contributions to economic development over time. They expatiate that Shariah provides some intermediation contracts that facilitate an efficient and transparent execution and financing of economic activities. These contracts are comprehensive enough to provide a wide range of typical intermediation services such as asset transformation, a payment system, custodial services and risk management, explain Greuning and Iqbal.

They submit that for Islamic financial institutions, the nature of financial intermediation is different from that of conventional financial institutions. In the words of these authors, “A typical Islamic bank performs the functions of financial intermediation by screening profitable projects and monitoring the performance of projects on behalf of the investors who deposit their funds with the bank.”

In chapters three and four, they discuss the concepts of partnership in corporate governance and key stakeholders.

Part two is eclectically christened “risk management”, and covers six chapters, that is, chapters five to 10. Chapter five is thematically tagged “framework for risk analysis”. Greuning and Iqbal here say the goal of financial management is to maximise the value of a bank, as defined by its profitability and risk level. They add that financial management comprises risk management; a treasury function; financial planning and budgeting; accounting and information systems; and internal controls.

In chapters six to ten, Greuning and Iqbal beam their analytical searchlight on concepts such as balance sheet structure; income statement structure; credit risk management; ALM, liquidity and market risks; and operational and Islamic banking risks.

Part three has the summary subject matter of “governance and regulation”, and covers four chapters, that is, chapters 11 to 14. Chapter 11 is entitled “governance issues in Islamic banks”. Here, these financial experts assert that the corporate governance arrangements of Islamic banks are modelled along the lines of a conventional shareholder corporation.

They add that however, Islamic finance raises unique challenges for corporate governance. According to these authors, the first revolves around the need to reassure stakeholders that the Islamic bank’s financial activities comply fully with the precepts of Islamic jurisprudence. Greuning and Iqbal add that the second revolves around the stakeholders’ need to be comforted in their belief that Islamic banks will promote their financial interests, proving to be efficient, stable, and trustworthy providers of financial services.

In chapters 12 to 14, they analytically X-ray concepts such as transparency and data quality; capital adequacy and Basel II; and relationship between risk analysis and bank supervision.

Part four, the last part is conceptually woven together as “future challenges”, and covers one chapter, that is, chapter fifteen also entitled “future challenges”.

As regards style, this text is an embodiment of success. For instance, to enhance readers’ understanding, Greuning and Iqbal include “Key Messages” section in every chapter where the main points are highlighted. These authors generously use graphics to achieve effective visual communication reinforcement. The language of the text is highly literate and financially technical because of the subject matter, yet it is contextually understandable. What’s more, the text is very deep in contents.

However, some errors are noticed in it. One is the error of structural redundancy: “He holds doctorate degrees….” (page xxi) instead of “He holds doctoral degrees….” or “He holds doctorates….” “Doctorate” is a noun and means “A university degree of the highest level”; while “Doctoral” is the adjective and can be used with “Degree”. “Longman Dictionary of Contemporary English” 2005 edition, page 460 illustration says, “She received her doctorate in history in 1998.”

Another error in the book is “…some new presentations and a perspective that offers…” (page xv) instead of putting a comma immediately before “And”, a coordinating junction of adding, to terminate the nominal plurality effect of the word “Presentations”, so that the third person singular (pro)noun verb “Offers”, can operate exclusively with “A perspective” thus: “…some new presentations, and a perspective that offers….”

Generally, the text is an eye-opener. It is highly recommended to regulators and operators in the financial services industry, especially those in the banking sub-sector. It is a reservoir of rare banking knowledge.