Risk Management for Islamic Banks. Imam Wahyudi

and infrastructure necessary for the construction of a reliable risk management system. Chapter 5 covers the Islamic bank's financial statements and related analyses. In this chapter, we will explore the details related to the structure of financial statements (on balance sheet, income statement, off balance sheet, etc.), the philosophy of financial statement construction, the available financial statement analysis tools, and how to integrate financial statement analysis into the risk management framework.

       Part III will specifically discuss the characteristic, profile, philosophy, coverage and distinct character of all the risks faced by the Islamic bank. Apart from that, there will also be an explanation of the identification process of “key risk factors” of the business process of each product and the bank's business activities, how the tools and policies of risk mitigation are constructed, and various issues related to those risks in the framework of developing the Islamic banking institution. This part consists of seven chapters. Chapter 6 discusses financing risk in an Islamic bank, including the function of the Islamic bank, the urgency of financing risk management in an Islamic bank, the Islamic bank's financing risk profile, the definition and scope of financing risk, the role of rahn (asset collateral) and kafalah (third party guarantee), and various other factors that determine financing risk. Afterward, the urgent need for an independent rating agency is also discussed, as are the role of financing risk provision, financing limit strategies based on risk profile, concentrated financing portfolio risks, the management of financing portfolios, and how to construct the best practice of financing risk management by optimizing the synergic relationship between interrelated institutions. Chapter 7 discusses the Islamic bank's operational risk; it covers the concept and definition of operational risk, the relation between operational risk and Islamic bank's business, the importance of building consciousness on the presence of risks when operating the business, the definition and scope of operational risk, identification of the various determining factors of operational risk, how to measure operational risk in an Islamic bank, and how to build a reliable operational risk management in an Islamic bank.

       Chapter 8 discusses syari'ah-compliance risk. This risk needs to be covered in higher detail, considering many Islamic banks carry the mission of manifesting the principles of Islamic syari'ah in the Islamic bank's business practices. In this chapter, the basic principles of Islamic financial system and economy are discussed; the basic philosophy that syari'ah is the principle and spirit in business, as well as the various prohibitions in mu'amalah. Why the Islamic bank should be syari'ah-compliant in its business is also discussed, as well as the ways that syari'ah-compliance should be an integral part of policies and management processes at all levels of the Islamic bank, the urgency for the national syari'ah council and the existence of a syari'ah supervisory board in an Islamic bank, and the relationship between the syari'ah supervisory board and the syari'ah-compliance audit as part of a framework. The final part of this chapter discusses the syari'ah-compliance risk identification process and how to build risk management and mitigation for syari'ah-compliance in an Islamic bank.

       Chapter 9 covers an Islamic bank's strategic risks. This chapter specifically discusses the concept of strategic risk for the Islamic bank, the scope and definition of strategic risk, the determinants of strategic risk, and how to mitigate it, as well as the issues relevant to strategic risk. Chapter 10 discusses investment risk in an Islamic bank. This chapter covers syirkah as a distinct characteristic of Islamic banks, the basic concept of investment risk, the forms of investment risk and its mitigation, as well as covering several issues related to investment risk in an Islamic bank, such as the basis of determining profit-sharing ratios, the policy of profit equalization reserve (PER), investment risk reserve (IRR), and investment risk (IR) support in reducing fraud and moral hazard in a profit-loss-sharing-based contract.

       Chapter 11 discusses an Islamic bank's market risk. The beginning of the chapter will touch on the basic differences between the market risk of a conventional bank and those of an Islamic bank. Then, we will discuss the identification process and measurement of market risk in an Islamic bank, the mitigation method that is appropriate to the Islamic bank's character, and the application of risk mitigation methods in an Islamic bank. Chapter 12 discusses liquidity risk in an Islamic bank. This chapter specifically discuss the definition, basic concept, and philosophy of liquidity risk for a bank, as well as the definition and scope of liquidity risk, asset, and liability management in an Islamic bank. Last, liquidity risk management for Islamic banks will also be discussed.

       Part IV discusses the potential and challenges of the Islamic bank in the future. This part consists of four chapters. Chapter 13 covers the development of the Islamic financial market, both from the institutional side as well as from the financial products traded. Chapter 14 discusses the development of pricing methods in the Islamic bank. It discusses the urgency for Islamic banks to develop their own pricing systems independent from a usurious reference rate, such as the market interest rate. Various approaches are discussed, such as the microeconomic of banking approach, the real sector's rate-of-return, the productivity-based pricing model, and the like. Specifically, we provide an illustration of pricing construction on a salam product; from this, the pricing method for other Islamic financial products can consequently be developed. Chapter 15 covers the pathways of risk management in an Islamic bank and various related issues, beginning from correcting any possible misapprehension on the Islamic bank, and how the Islamic bank itself is an actual implementation of risk management. The Islamic bank is an alternative and practical solution compared to the weakness of the current conventional financial system. After this, we will discuss sequentially the challenges faced by Islamic banking in Indonesia as well as the blueprint for Islamic banking. Other important issues are the potential for moral hazard and the lack of a global super-body institution, such as an international arbitrage and mediation institution for Islamic banks, an international syari'ah judicial institution, or a global regulator. This chapter also discusses the development potential of Islamic banks and their challenges, the strategic issues of risk management application in an Islamic bank, as well the form of Islamic banking risk management in the future. The pros and cons of syari'ah-based products and syari'ah-compliant products will be discussed, as well as the risks behind the usage of profit-loss-sharing scheme, the implications of mudharabah mutlaqah versus mudharabah muqayyadah, and how the Islamic bank answers the challenge of creating a syari'ah-compliant product. Then, Chapter 16 discusses the future agenda of Islamic bank's risk management development, the potential for synergy between Islamic financial institutions, the requirements and competencies that must be built and prepared for, and the direction of regulation in the future. To build Islamic banking risk management in the future, continuous development of the risk management system and an integrated risk management landscape development. Finally, Part V is the conclusion of this book.

      Imam Wahyudi

      Fenny Rosmanita

      Muhammad Budi Prasetyo

      Niken Iwani Surya Putri

      Depok, March 2015

      Acknowledgments

      Alhamdulillahi Rabbil ‘alamiin, all praises belong only to Allah Ta'ala. With His blessings and favors, this book can be finished.

      It is true what is advised by Imam Muhammad bin Idris asy-Syafii al-Quraisy rahimahullahu Ta'ala:

      O my brother … knowledge is not gained unless through six things that I will tell in detail: