12 November 2013 |

RISK MANAGEMENT IN ISLAMIC BANKING

Anita Menon

Chief Risk Officer

Prudential BSN Takaful Berhad

IBBM Risk Management Conference 2013

11-12 November 2013

Kuala Lumpur, Malaysia

Agenda

• Introduction

• How To Ensure Risk Management Is Embedded At The Heart Of The Business?

• What Are The New Drivers Shaping The Role Of the CRO In Islamic Finance?

• Summary

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INTRODUCTION

The Changing Regulatory Landscape Challenges for IFIs

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BASEL III "Basel III" is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector.

Islamic Financial Services Board The risk management standard sets out 15 principles of risk management for institutions (other than insurance institutions) offering only Islamic financial services (IIFS). Requirement to comply with Shariah rules and principles especially the prohibitions of generating profits without bearing any risks. However, IIFSs’ fiduciary duty requires it to apply Shariah compliant risk mitigation techniques wherever appropriate.

BNM Risk Governance The policy document on Risk Governance describes the supervisory expectations on risk governance practices in financial institutions :- • Roles of the board and senior

management oversight. • Independence of risk management

and control functions. • Importance of having a holistic view

of all relevant risks • Ensuring that reporting of risks

provides an integrated view which points to an ERM type approach

Islamic Financial Services Act 2013 (IFSA) The new Act came into force in July 2013 and will be a landmark law, perhaps the only omnibus Islamic finance legislation in the world. It could easily be called the Islamic Financial Stability Act for it lays the foundation for a comprehensive regime to promote a robust and resilient Islamic financial system in Malaysia.

BNM Shariah Governance Framework The Framework is designed to meet the objectives of outlining BNM's expectations on an IFI's Shariah governance structures, processes and arrangements, and providing comprehensive guidance to the key functions in discharging its duties relating to Shariah, in order to ensure that all its operations and business activities are in accordance with Shariah principles.

Considerations For IFIs The Unique Risk Faced by IFIs

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Financial Risk Operational Risk

Shariah Compliance Risk

Potential losses due to non-compliance with

Shariah rules e.g. penalty and reputation

Investment Risk

Rate of Return Risk

Exposed in the context of their overall balance sheet exposures. An increase in

benchmark rates may result in profit-loss sharing deposit holders’ having expectations

of a higher rate of return

Fiduciary Risk

Arises from IFIs’ failure to perform in accordance to

explicit and implicit standards applicable to

their fiduciary responsibilities

UNIQUE RISKS SPECIFIC TO IFIs OTHER THAN THOSE FACED BY ALL IFIs

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Shariah Governance Framework Model for IFIs

HOW TO ENSURE RISK MANAGEMENT IS EMBEDDED AT THE HEART OF THE BUSINESS?

What is Risk Management

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An “effective” risk management system is one where there is an

appropriate risk culture, decisions (at all levels) are based on an

understanding and consideration of risks, and risks that are either above

or below risk targets are managed towards that target.

Enterprise Risk Management (ERM)

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Broadens risk awareness

Aligns risk profile

and strategy

Minimises surprises

and losses

Rationalises capital

requirements

Assures regulatory

compliance

Improves ROE and

shareholder value

Business Risk

Financial Risk

Strategic Risk

Operational Risk

CRO

Risk Management

Risks

Business

Unit &

Process

Risk

Management

/Compliance

/Shariah

Board

Executive

Benefit

Enterprise Risk Management (ERM)

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The ERM foundation is built on 5 factors

ERM

Risk Management

Culture

Risk Models

Risk Controls Strategic Risk Management

Emerging Risk

Management

System of Governance Risk Management Needs to Cover All Aspects

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Board

Reporting Measurement and

Control Operations

Risk assessment/

Response

Business objectives

and strategy Risk strategy Value proposition Risk appetite

Risk awareness/

Identification

Organisation and

people

Limits and

controls Methodologies Systems Data Policies Reporting

Culture Training Communication Performance measures Reward

Strategy

Process

Infrastructure

Environment

Validation/

re-assessment

Supervise Framework of

objectives Safeguard Oversight

Risk Governance 3 Lines of Defence

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Senior Management

Board of Directors

1st Layer of Defence

Business Units

2nd Layer of Defence

Risk Management

Compliance

Shariah

3rd Layer of Defence

Internal Audit

Risk Acceptance,

day to day

dealings

Risk control unit,

oversight, policies

& framework

Independent

assurance

Audit Committee Board Risk

Management Committee

Shariah Committee

Investment Committee

WHAT ARE NEW DRIVERS SHAPING THE ROLE OF THE CRO IN ISLAMIC FINANCE?

Developments In Local Regulation

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BNM Risk Governance

The Principle 6 in Risk Governance describes the role of the CRO in financial institutions

• Financial institutions must establish an independent senior risk executive role (chief risk officer or its equivalent).

• The role of the chief risk officer (CRO) must be distinct from other executive functions and business line responsibilities.

• The CRO must be positioned at a sufficiently senior level in the organisation to enable risk considerations to be raised directly to the board and senior management.

• The CRO must report and have direct and unimpeded access to the board and its risk committee.

External Factors

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• Stock and bond markets remain volatile...

• Europe continues to face recession…

• US political chaos and debt ceiling row…

• Food and energy prices continue to rise...

• GDP slowdown in BRIC countries...

• Protests continuing in many countries...

Role of the CRO in IFIs

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Development of an ERM type

approach

Risk Measurement and

Reporting

Risk Assessment of business

strategy

Capital Management

Regulatory Compliance

Management and influence of other key stakeholders

Oversight of Shariah Risk

Management

Oversight of investment

management

SUMMARY

In Summary ERM is an end to end process

Planning and Designing the Approach and

Concept

Implementing an Integrated approach to

Risk Management

Embedding Risk Management within

the Business

Continuously Improving the Integrated Risk

Management Framework

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12 November 2013 |

Thank You