Risk is a natural element of banking business. It is a condition that raises the chance of losses and uncertain potential events which could manipulate the success of the financial institutions. The uncertain future events could include disappointment of a borrower to pay back a credit, variation of foreign trade rates, fraud, non-compliance with laws and principles and other actions due to the failure of the bank (Khan & Ahmed, 2001; Meyer, 2000; Khalid & Amjad, 2012). As Khalid & Amjad (2012) noted commercial banks are in the risk business. In the process of providing financial services, they assume various kinds of financial risks.
Risk sharing is another principle for Islamic banking system. Although interest is prohibited in Islamic banking system, they still can operate by the concept of profit and loss sharing which is utilizing the funds at risk. When there is no guarantee of return, people will be encouraged to involve in maximize their exertion to contribute justify into production process. Mudarabah and Musharakah are two types of forms which are most desirable in profit and loss sharing concept. Under these two forms, financier makes the funds available as an investor instead of as a lender.
In other words, a bank’s balance sheet provides the bank’s financial position. The bank’s balance sheet on one side indicates the sources of funds which is known as liabilities and capital while the other side of the bank’s balance sheet indicates the use of funds which is known as assets. Moreover, in terms of knowing the size of a bank’s balance sheet, the leverage ratio is used. The leverage ratio is the future losses that a bank is possibly exposed to, relative to its own capital. Based on regulatory requirement, as the ratio of capital towards total assets, it reflect upon the riskiness of a bank, since it absorbs the losses of the asset of the bank.
According to Abdulkareem Abu al Nasr, The CEO of NCB, or Al-Ali Bank, global financial crisis happens because of " excessive use of structured debt and securities which drove unsustainable levels of financial leverage'' (Could Islamic Banks Help, 2012). On the other hand, Islamic banks that prohibits riba prevents this kind of situation from happening. Islamic banks focused their activities mainly on domestic markets, where most of the activities involved tangible objects instead of debt based financing. That way, Islamic banks would not be seriously affected even when financial crises hits the economy. Conventional banks gain their profit mainly from giving out loans to borrowers and receive interest in the process by using money deposited by customers.
Interconnectedness serves as a channel for contagion. The impact of the failure of large interconnected entities can spread swiftly and widely across the financial system, where it can cause universal financial instability. In general, financial interconnectedness refers to relationships between economic mediators that are created through financial transactions and supporting arrangements. The term interconnectedness refers specifically to linkages between and across financial institutions i.e. banks and non-banks, providers of financial market infrastructure services i.e.
Risk management depends on the internal and external environment of the banks, that is why constant consideration should be given to risk identification and control (Hussain and (Al-Ajmi, 2012; Tchankova 2002), so that risk should be identified and a decision should be taken whether to mitigate, transfer or accept the identified risk depending upon the situation. A volatile macroeconomic environment with uneven economic performance, unstable exchange rate and asset price are causing volatility in the financial system. Such an environment makes it difficult for banks to evaluate their assets and financial risks realistically, such as unstable macroeconomic conditions causing higher probability of credit risk exposure to the banks. Furthermore,
1.0 Overview of Study This study is examines the empirical relationship and effect between liquidity risk and profitability performance in Malaysia banking industry. Liquidity risk is an important aspect of the banking risks. This riskiness of its portfolio and operations usually will straightforwardly vary a bank’s profitability. According to Matthews and Thompson (2008), liquidity risk refers to the likelihood inability of a bank to convene its liquid liabilities due to unpredicted extraction of deposits. The bank is incapable to meet its liability requirements but also unable financed its illiquid assets is the example of an unexpected liquidity shortage.
Risk Management For Banking Companies Risk management is the process of assessing risk and developing strategies to manage the risk. In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss and greatest probability of occurring are handled first. In practice the process can be very difficult, and balancing between risks with high probability of occurrence but lower loss & risks with high loss but lower probability of occurrence can often be mishandled. Financial firms face four common risks: Market risk refers to possibility of incurring large losses from adverse changes in financial asset prices, such as stock prices. Standard risk management involves use of statistical models to forecast probabilities & magnitudes of large adverse price changes.
There are two ways in which Islamic banks will be involved in Mudharabah contract. First, the contractual relationship between the bank and its customers is based on the principle of Mudharabah and the bank will act in its capacity as mudharib after customers open an investment account. And secondly, Islamic banks can also be the capital provider where they wil... ... middle of paper ... ...ts or liabilities. While there are core deposit rolled over and will not be volatile, but provide a cushion is an important thing for Islamic banks. Moreover, the deposit that remaining the uncertainty cannot easily be matched with short-term liquid assets except other than cash and assets other low returns.
While, the insufficiency of an effective corporate governance framework restrained the independence of board of directors (BOD) also give the impact in risk management and poses a challenge to it. On the other hand, the requirement of shariah compliance is one of the challenges as the application of practice that contradicts with the shariah is prohibited. Islamic financial market is one of the issues that can affect the risk management because it is not easy to bear especially for takaful institution to maintain its liquidity position to make prompt claim payment when it was demand to pay it. Other challenge is a need of private credit rating agencies, this situation is difficult to overcome when there is a problem due to the International Islamic Rating Agency (IIRA) in Bahrain which to judge the shariah compliance and financial strength of the islamic financial institution in rate thousands of counterparties with whom Takaful companies deal. Lastly, the financial engineering poses as the major threat to Islamic Financial Institutions to become competitive in the contemporary business environment because of the different academic backgrounds and the opinion of the shariah scho... ... middle of paper ... ...ive to ensure both of these elements are managed fairly because both of them are crucial in takaful institution as a financial institution.