Risk Management Principles

Risk management refers to the overall process that a financial institution follows to define a business strategy, to identify the risks to which it is exposed, to quantify those risks, and to understand and control the nature of the risks it faces. From a risk management perspective, risks facing financial institutions can be classified into three types: risks that can be eliminated, risks that can be transferred to others, and risks that can be managed by the institutions themselves. Financial intermediaries avoid certain risks by simple business practices and will not take up activities that impose risks upon them. The practice of financial institutions is to take up activities in which the risks can be efficiently managed and to shift the risks that can be transferred.

Types of Risk

As most depositors and investors use IFIs due to their Islamic character, financial institutions must ensure that all their activities conform to the principles and values of Islam. This would require contracts and all necessary supporting documentations, including the legal papers, forms and processes, to be Shari’ah-compliant. For further details see: ISRA, Islamic Financial System; Principles and Operations.

Credit Risk is a risk where the counter-party will fail to meet its obligations on time and in accordance with the agreed terms due to volatility in default rates and credit qualities.

Can Earnest Money Be Kept if the Purchase Orderer Reneges on the Deal?

Market risk is the risk originating from instruments and assets traded in markets. Market risks can result from macro and micro sources.

The risk that the terms or conditions of a contract or agreement will prove unenforceable due to legal defects in the contract or in related documentation and procedures. For further details see: FINANCIAL RISK MANAGEMENT: A Practitioner's Guide to Managing Market and Credit Risk.

Liquidity risk is the potential loss to IFIs arising from their inability to meet their obligations or to fund increases in assets as they fall due without incurring unacceptable costs or losses.

The Shariah Advisory Council of Bank Negara Malaysia (the SAC) 150th Meeting

Operational risk is the risk arising from inadequate or failed internal processes, people and systems or from external events. For further details see: ISRA, Islamic Financial System; Principles and Operations.

Legal Constraints on Buying Shares of Limited Liability Companies

Reputation risk is the potential that negative publicity regarding a firm's practices and actions will cause a decline in the customer base, costly litigation, revenue reduction, liquidity constraints, or significant depreciation in market capitalization. Reputation is one of the most valuable assets a company can have, and one of the most difficult to protect. For further details see: RISK MANAGEMENT: A Modern Perspective.

Contractual Agreements Prevent the Intermediate Murabahah Seller from Buying the Good at the Cheapest Available Price

Longevity risk is the risk that advances in medical sciences and lifestyle changes will lead to people living longer. For further details see: Risk Management and Financial Institutions (Third Edition)

Macroeconomic risk depends on uncertainty in the environment of all firms in a country, though the impact on individual firms or their exposure is firm-specific. For further details see: CORPORATE DECISION-MAKING WITH MACROECONOMIC UNCERTAINTY: Performance and Risk Management.


Instruments

The Securities Commission of Malaysia (SC) defines structured product in its Guidelines on Structured Products under para 1.03 as: 1.03 for the purposes of these guidelines: (a) The term structured product means any investment product that falls within the definition of securities under the SCA [Securities Commission Act 1993] which provides the holder with an economic, legal or other interest in another asset (underlying asset) and derives its value by reference to the price or value of the underlying asset; (b) The term underlying asset means any security, index, currency, commodity or other assets or combination of such assets. A derivative is a financial instrument whose value depends on the value of other, more basic, variables such as grains, crude oil, palm oil, currencies, or indexes.

Forward Foreign Currency Transaction
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Issues and Challenges


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