4005_3969_Morisano - Managing Uncertainty in an Islamic Financial Institution_presentation

7/31/2019 4005_3969_Morisano - Managing Uncertainty in an Islamic Financial Institution_presentation

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Managing Uncertainty in an Islamicfinancial institution

Presentation to the PRMIA Singapore Chapter

May 2010


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This document is exclusively intended for use by selected clients. Distribution, quotations and duplications even in the form of extracts for thirdparties is only permitted upon prior written consent of Ma Lee Advisory, Limited.

Copyright 2010 Ma Lee Advisory, Limited.

The text and graphs compiled in this presentation do not represent complete documentation.


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Managing and understanding risk overcomes uncertainty

The management of risk is a process by which exposures in a financial institution are

identified

measured and assessed

mitigated and controlled

reported and monitored


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Agenda

Brief Overview of Islamic finance

Common risks faced by Islamic financial institutions and their financial instruments.

Specific risks of Shari'ah compliant banking products

Reducing risk in Islamic financial institutions


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Background

Islamic financial institutions (IFI) are operating in over 75 countries, managing between $500billion and $1 trillion assets

Islam prohibits dealing in interest as well as any investment in liquor, swine/pork products,gambling, pornography and anything else, which the SharIah deem unlawful

Islamic financial system employs the concept of participation in the enterprise, utilizing thefunds at risk on a profit-and- loss-sharing basis

Islamic banking, with 15 to 20% growth a year, has emerged as one of the vital pillars of theglobal economic system

Increasing linkages between OIC financial centers such as Kuala Lumpur, Dubai and Bahrain

Significant interest in Islamic finance being shown by countries such as UK, France,Australia, Singapore, Hong Kong, China and Japan


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Focus : Islamic Finance News (Reuters)

Significant insight into real-time Islamic events

Source: ThompsonReuters


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What is an Islamic financial institution

Financing InvestmentMoneyMarket

Islamic Financial Institution

Shareholder Depositor


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Features of Islamic banking

Interest (riba)-free - money is only a medium for exchange; one can not earn more money byitself without putting it real productive, action

Uncertainty or lack of knowledge (gharar)-free must avoid all disputes due to unfairness indealings due to lack of knowledge

Gambling (maysir)-free - transfers of wealth, not the creation of new wealth

Not involved in something impure or not halal -religious and ethical value considerations

Not in direct conflict with established Shariah principles in muamalah


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Focus : Islamic Glossary (Reuters)

A glossary for clarifying even the most esoteric products



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Recent market events

Repatriation of dollars by Arab investors

Liquidity due to oil revenues

Sukuk defaults

Dubai under crisis

Regulatory Activity


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Focus : Crisis & Islamic Finance [ISLF] (Reuters)

Up to date news on the latest industry developments



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Sovereign and agency debt issuance

Dubai: $1 billion

Qatar: $700 million

Pakistan: $600 million

Malaysia: $600 million

German State of Saxony-Anhalt:100 million

Bahrain: $79.5 million

Islamic Development Bank: $400 million

World Bank: $200 million


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Focus : Malaysian Sukuk (Reuters)

Everything you need to know about Sukuks



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Corporate debt issuance

DP World: 3.5 billion 7.5% Sukuk, convertible into equity at the time of a qualifying initialpublic offering

National Central Cooling Company: $200 million, rated BBB- by S&P


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Focus : DP World Sukuk Limited (Reuters)

Deep dive into specific issuances



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Focus : Terms and Conditions (Reuters)

and deeper



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Recent Singapore Developments

Singapore is encouraging the growth of Islamic finance and recently announced its intentionto become a hub of Islamic finance

Beginning in 2005, banks in Singapore were allowed to offer Murabaha financing

The Development Bank of Singapore (DBS) recently established the Islamic Bank of Asia, tofocus on wealth management and capital market instruments for corporate and privatebanking clients in the Middle East and Asia

There is a governmental initiative to achieve tax equality between approved Islamic productsand conventional financing arrangements

Singapore is moving quickly to remove the double stamp duty hit on Murabaha and Ijaracontracts

Tax incentives granted to qualifying debt securities extended to approved Islamic bonds

No stamp duty on the transfer of asset to SPV set up for Islamic Financing purposes


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Focus : Islamic Scene in Singapore (Reuters)

And of course a great source of local information



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Conventional international banks with Islamic activities

Citigroup

HSBC

Deutsche Bank

UBS

ABN AMRO

Standard Chartered Bank


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Focus : HSBC Islamic (Reuters)

Deep dive into a financial institutions activities



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Agenda






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Does Islamic banking risk differ from Conventional bankingrisk?

Islamic Banking is ALL about who bears risk

Trade credit ?

Asset backed secured or unsecured ?

Debt or equity ? Leasing ?

Repos / Murabahah ?

Fund management ?


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Risk profile of Islamic financial institutions

0%

20%

40%

60%

80%

100%

mur

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mudha

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musha

raka

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D.musha

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Credit Risk Market Risk Liquidity Risk Operational Risk


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unique risks in an Islamic financial institution

Rate of return risk

Shariah risk

Equity investment or position risk

Risk transformation

Unrealistic funding costs


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Focus : Risk Islamic (Reuters)

Ability to search on key words, like risk management activities



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Rate of return risk

Associated with the management of assets and liabilities

Fixed rate long term assets funded by variable rate short-term liabilities

Movement in benchmark rates may result in fund providers having expectations of a higher

rate of return

Subsequently, it may result in displaced commercial risk where due to market pressure,Islamic bank needs to pay a return that exceeds the rate that has been earned on its assets.

If Islamic bank does not yield to market pressure, they may lose their fund providers whichcould consequently lead to liquidity risk


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Shariah risk

Limited available talent pool, especially for positions on the Shariah board

It takes many years of education and practical experience to become a Shariah scholar

Different Shariah boards even within the same country may deliver different interpretations


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Agenda






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Unique Credit Risks

Refusing to honor the promise to buy a Murabaha contract

Refusing to honor the specific aspects of a Salam contract

Declining to honor the promise to accept the delivery agreement of a Istisna contracts

Non-compliance with the leasing structure of Ijara contracts


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Focus : More Islamic Risk Insights (Reuters)

Marketplace trends on Islamic finance



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Other risks may arise from various sources

Limited secondary trading market for Sukuk

Directly expose to commodity price risk because Islamic banks carry inventory items

Non-standardized nature of some Islamic products

The lack of an efficient and reliable Shariah legislation system to enforce financial contracts

Lack of risk-hedging instruments due to the prohibition against ribaand some fiqhissues inthe interpretation of ghararmean that many risk hedging instruments based on traditionaltools, such as option, futures and forwards are not available to Islamic banks

Underdeveloped money market and government securities based on profit loss sharing


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Islamic banks have ineffective liquidity management

Islamic banks tend to have a concentrated base of deposits and assets.

Islamic banks have been forced to hold a large proportion of their assets in reserve accountsin central banks or in correspondent accounts than conventional banks

Islamic banks face underdeveloped or nonexistent money markets


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Studies have also identified weaknesses and vulnerabilitiesin the areas of risk management and governance

The failure of systems, processes, and procedures, is one area of concern

The existence of weak internal control processes

The quality of management, technical expertise, and professionalism, is also an issue


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Then there is

A lack of good risk management professionals in the Islamic financial institution

Risk management Is not seen as a core competency

Education of the Boards is lacking on capital adequacy and risk mitigation


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Agenda






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Essentially an integrated approach to risk management,governance and compliance

Enterprise Risk ManagementIdentifying Risks That May Affect Our

Ability to Achieve ObjectivesAnd Determining How to Respond

ComplianceExecuting as Expected To Support Achievement of All Objectives

GovernanceDeterminingObjectives

and KnowingWe Are Executing

Appropriately


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Management, the Board, and the regulators each have arole to play in ensuring that risk is managed effectively

Management level

The quality of strategic and operational monitoring and management

Board level

The quality of questions being asked about the performance of the financial institution underthe worst-possible-stress scenarios

Regulatory level The quality of published regulatory requirements, so far these have lack any quantitative

criteria or guidelines


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Both the Board and management should ask questions

Do you feel your organization is taking the appropriate level of risk?

Do you know what the risks are for the organization you are supporting?

Does management agree on the importance of these risks?

Does management know the real level of impact and likelihood for these risks?

For risks that are undermanaged, does your organization have a plan in place to improve themanagement of these risks?

For risks that are over managed, does your organization have a plan in place to improve the

management of these risks?

Does your organization take inconsistent levels of risks?


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The Board must take responsibility for defining capacity,appetite and limits

Capacity

Capacity represents the maximum amount of risk that can be supported

Risk Capacity is determined by considering the following:

Availability of capital resources

Ability to raise capital (access to capital markets)

Earnings strength and stability - growth in capital over the planning horizon

Appetite Risk Appetite serves as an overall guide to resource and capital allocation

Business strategy must be aligned with risk appetite

Limits

Risk Appetite should be allocated to individual risk types, businesses based upon capital

requirements relative to potential returns and risk concentrations

Limits should effectively control risks within the context of the overall risk appetite

Limits should reflect enterprise Risk Preferences and align to support strategic plans andcapital allocation

Limits should be set at a level which may be periodically tested (i.e., limits should beestablished at levels that may be exceeded at times)


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Management must measure risk and provide frameworks toeffectively control risk taking

A robust liquidity risk management framework and governance process

Gap analysis for a timeframe in which meaningful actions can be taken or one far enoughforward that underlying information can be relied upon with a significant degree of certainty

Detailed understanding (nature and purpose) of assets held and liabilities, contingentobligations, the reliability of credit availability, and the potential market reaction to actionsconsidered to be taken the in response to market behaviors

Implement information systems


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The Islamic financial institution should align businessstrategy to risk tolerance

How much on balance sheet exposure is allowed

What is the proportion of total reliable liquidity

What is the maximum refinancing requirement during a period (day, week, etc)

What concentration is allowed by

Any one provider

Any one product

What is the target surplus based on expected or worst case probabilities?


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Challenges in Islamic finance

Organization and resource issues

Liquidity management constraints

Currency risk and volatility

Repatriation issues

Regulation constantly changing

Information and data restraints

Internal control issues

Shariah compliance is crucial


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Question & Answer


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About Ma Lee Advisory, Limited

Ma Lee is a boutique Asian advisory firm, focused on client service through a soundstrategy of producing and implementing results. The firm delivers solutions in threeprofessional areas, Strategy, Risk Management, and Corporate Finance, with thesupport of seasoned subject matter experts with over 20 years of exceptional, practical

experience in industry, Big-4 accounting firms, and consultancies. Since inception, threeyears ago, Ma Lee has been advising some of the largest financial institutions acrossAsia, from our home office in Hong Kong. Project delivery occurs on the Chinesemainland, Korea, Malaysia, Singapore, as well as within the GCC.

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4005_3969_Morisano - Managing Uncertainty in an Islamic Financial Institution_presentation