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on 11 June 2015

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Credit Risks by Shariah Contract
Credit Risk Mitigation
Importance of the Topic
In the past, theoretical studies on Islamic banking have focused on Islamic modes of financing and their ability to perform financial inter mediation for catering to the needs of people so as to be substitutes for loans while ensuring the compatibility of these modes with laws regulating banking operations. Banking supervision, however, has not received its due share in these studies. It is well known that banking supervision is concerned with various aspects of risk in banking operations. As the bank is a trustee of public funds, it is incumbent upon it to utilize these funds in ways that protect the rights of the owners of these funds. Therefore, comparative studies on risk underlying Islamic modes of finance are extremely important. They promote a sound understanding of various aspects of Islamic banking operations, an understanding that is needed by supervisory institutions. Likewise they encounter an objection that Islamic modes of finance carry much higher risks than interest-based loans.
Risk Profile of Islamic Bank
Credit Risk Management in Islamic Banks
Collections & Recovery
Group Members
Ahsanullah Khan
Hira Sarfraz
Sheherazade Fatima
Zarmeena Khan


Salam / Istisna
In case of a non-binding Ijarah, the Bank runs the risk of having to sell the asset at a (much) lower price. Bank also runs the risk of residual vale at end of the lease.

Normal credit risks with respect to
Asset periodical payments of installments
Exposed when Bank delivers asset to Customer but does not receive payment on time. Higher risk in non-binding MPO

The sequence of the ownership transfer of asset and the fact that 2 traders are involved could expose the Bank to price risk.

Normal credit risks of non-payment or not according to contract during the life of the transaction
Principal – Agent problems; Adverse
selection by Customer (info asymmetry)
Risk especially high when info asymmetry is high and in cases of low transparency (in case Bank does not have appropriate rights to monitor participate in management of project)
In case if misconduct/negligence of
customer, Bank’s share of capital is
transformed into debt liability (different rules apply to recovering debt)
Higher capital credit charge
Salam / Istisna
Bank is exposed to failure of customer to supply on time or at all, or if specifications of goods/project are not according to agreement. Hence payment could not be secured by selling commodities or project.

Bank usually enter into parallel
Salam/Istisna, but contracts must not be linked. Hence if one leg falls away, the bank is still liable to perform under the other leg.
Know your Client / Enhanced Due Diligence

Application Scoring Models

Shariah Compliant Enforceable Collateral and Guarantees

Clear Documentation

Operational Considerations

Proactive Monitoring

Active Monitoring by Recovery Team
Shariah Compliant techniques (a few examples)
Credit Risk Monitoring
Credit and Customer Profiling (example next slide)
Pro active monitoring (early detection system)
Post mortem reviews
Sector reviews
Stress Testing
A procedure aimed at obtaining the repayment of a debt after the obligation payment due date. Preventing account from being impaired or loss
A process to collect money still owed on accounts after
the financial institution has classified the account as
impaired or has written off the account as a loss
Collection Tools and Approach
Collection system
To assist better management of delinquent accounts

Reminder letter
Letter to reminder customers on their overdue payment at various delinquent stage

Auto Dialer
Automated dialer machine to improve contact rate

Short Messaging System (SMS)
Short & Precise message to reminder customers on their overdue payment.

Internet and Email
To locate customer’s contact and email reminder from the Bank to notify
customers on their overdue payment.
Difference Between Islamic VS Conventional Banks
Full transcript