Risk Management Practices and Risk Management Processes of Islamic Banks

Project Report on Risk Management Practices and Risk Management Processes of Islamic Banks

Dissertation Proposal on Risk Management Practices and Risk Management
Processes of Islamic Banks

Thesis Research Proposal on Risk Management Practices and Risk Management
Processes of Islamic Banks

This paper proposes a research framework on risk management practices and the aspects of risk management processes. The four important aspects of risk management processes are: (1) understanding risk and risk management; (2) risk identification; (3) risk analysis and assessment; and (4) risk monitoring. Conceptual and empirical literatures are explained to suggest the conceptual model. The framework suggests that there is a positive relationship between risk management practices and the aspects of risk management process. Then, the discussions are used to generate research hypotheses to suggest the relationships. Hence, further research can prove empirically the relationships and hence provide contribution in the area of Islamic banking.

A robust risk management framework can help IBs to reduce their exposure to risks, and enhance their ability to compete in the market (Iqbal and Mirakhor, 2007). A reduction in each institution’s exposure will reduce the systemic risk as well. Hence, it is necessary that IBs have in place a comprehensive risk management and reporting process to identify, measure, monitor, manage, report and control different categories of risks. In addition, this process should pay attention to compliance with Shari’ah rules and principles. The objectives of this paper are to suggest conceptual framework and relationships between risk management practices; and (1) understanding risk and risk management; (2) risk identification, (3) risk analysis and assessment; and (4) risk monitoring. There are five (5) important questions in this respect are as follows:
1. What is the relationship between risk management practices; and understanding risk and risk management?
2. What is the relationship between risk management practices and risk identification?
3. What is the relationship between risk management practices; and risk analysis and assessment?
4. What is the relationship between risk management practices and risk monitoring?
5. What are the factors (i.e. understanding risk and risk management; risk identification; risk analysis and risk assessment; and risk monitoring) that influence risk management practices?

Understanding Risk And Risk Management

It is important for staff of banking institutions to understand the aspect of risk in the banking operations and the risks that are inherent and exposed in their business operations. Better understanding of risk management  as also necessary especially in the financial intermediation activities where managing risk is one of the   important activities. A study conducted by Boston Consulting Group (2001) found that the sole determining success factors is not the technical development but the ability to understand risk strategically and also the  ability to handle and control risk organizationally. Secondly, in order to realize a risk based management philosophy, the attitude and mindset of the employees need to be changed whereby they must be brought to understand that managing risk is crucial for success. This implies that there must be intensive training, clearly defined structures and responsibilities, as well as commitment to change. In addition, it was identified that banks in North America and Australia concentrate on risk management primarily to enhance their competitive positions. Meanwhile in Europe, Asia and particularly in South America, risk management is considered primary from the perspective of regulatory requirements. Then, Al-Tamimi and Al-Mazrooei (2007) found that the UAE banks staff have good understanding of risk and risk management, which might give an indication about the ability of these banks to manage risks efficiently in the future. Moreover, understanding risk and risk management had positive effect on risk management practice although it is insignificant. From the literature, it shows that understanding risk and risk management is an important factor of risk management practices; hence, the proposed hypothesis is as follows;

H1: IBs staff that understand risk and risk management have good risk management practices.

Risk Identification

There are few conceptual studies on risk identification of financial institutions (e.g. Kromschroder and Luck, 1998; Luck 1998;; Pausenberger and Nassauer, 2000; Tchankova, 2002; Barton et al. 2002 ) and few empirical studies that include risk identification of banks (e.g. Al-Tamimi, 2002; Al-Tamimi and Al-Mazrooei, 2007). Risk identification is the first stage of risk management (Tchankova, 2002) and a very important step in risk management (Al-Tamimi and Al-Mazrooei, 2007). The first task of the risk management is to classify the corporate risks according to their different types (Pausenberger and Nassauer, 2000). The first step in organizing the implementation of the risk management function is to establish the crucial observation areas inside and outside the corporation (Kromschroder and Luck, 1998). Then, the departments and the employees must be assigned with responsibilities to identify specific risks. For instance, interest rate risks or foreign exchange risks are the main domain of the financial department. It is important to ensure that the risk management function is established throughout the whole corporation; i.e. apart from parent company, the subsidiaries too have to identify risks, analyze risks and so on.

Pausenberger and Nassauer (2000) also state that it is advisable for most corporations to implement early warning systems. An early warning system is a special information system enabling the management board to identify risks in time by observing the development of defined indicators (Luck, 1998). Other instruments that could be used to identify risks are checklists of possible disturbances or breakdowns, risk workshops, examination of corporate processes, internal inspections and interviews, loss balance, etc. It is advisable to make use of the knowledge and skill of external experts, for instance, forecasts of banks about the development of interest rates or foreign exchange rates. There are many other approaches for risk identification, for instance, scenario analysis or risk mapping. An organization can identify the frequency and
severity of the risks through risk mapping which could assist the organization to stay away from high frequency and low severity risks and instead focus more on the low frequency and high severity risk. Risk identification process includes risk-ranking components where these ranking are usually based on impact, severity or dollar effects (Barton et al. 2002). According to him, the analysis helps to sort risk according to their importance and assists the management to develop risk management strategy to allocate resources efficiently.

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