Understanding Islamic Finance - Doha Academy of Tertiary Studies

452 Understanding Islamic Financebusiness has occurred without any misconduct or negligence on the part of the client who isa partner of the bank.Practically, however, there may be a requirement that, in certain cases, the conditionrelating to collateral be relaxed to enable clients of small means to conduct some microlevelbusiness. Experience has shown that small businesses and the middle class clients offinancial institutions do not adopt dilatory practices in payment of their liabilities. Therefore,IFIs should also launch some schemes to facilitate the unemployed and poor people to startsome business to earn sustenance on the basis of personal and/or group sureties.Risk Profile of Islamic BanksAnother misconception is that Islamic banks, like conventional banks, do not take on risk;they adopt modes and techniques such that they are able to get targeted income, as in thecase of conventional banking. The point to be emphasized in this regard is that risk-takingand risk management are two different aspects. Islamic banking involves risk-taking by itsvery nature; risk can be minimized by way of valid risk management tools but not totallyavoided or eliminated. Conventional banks give and take risk-free returns in the sense thatthe principal and an addition over it in the form of interest is guaranteed; depositors andthe banks are entitled to get the full amount of the loan along with interest. If an amountgoes into default, it is due to a management/governance problem, as the contractual rightto receive the amount remains intact. This is not the case in Islamic finance; IFIs have toconduct real business, as a result of which they may earn a profit or incur a loss, and hencethey take on risk.The additional risks that Islamic financial institutions have to face as compared to conventionalinstitutions are asset risk, market risk, Sharī´ah-non-compliance risk, greater rate ofreturn risks, greater fiduciary risks and greater legal risks. Asset risk is involved in all modes,particularly in Murabaha (before onward sale to the client), Salam (after taking deliveryfrom the Salam seller) and Ijarah, as all ownership-related risks belong to the bank so longas the asset is in its ownership; if the asset is damaged without any fault on the part of thelessee and it is not able to deliver the normally intended benefit, the bank’s right to get rentalwill cease. In Shirkah-based modes, risk is borne as per the share in the ownership. Marketrisk is involved as the bank might not be able to market the goods purchased on the basis ofSalam, Istisna‘a, etc. at a profitable price. Rate of return risk is involved as the price, oncefixed in Murabaha/Salam, cannot be increased. Remaining within the Sharī´ah principles,Islamic banks are allowed to take risk mitigation/management measures. But transfer of riskto anyone else without transferring related reward is not permissible. Therefore, the criticismthat Islamic banks, like conventional banks, do not take business risk is not valid.Identical End Result of Conventional and Islamic BankingIslamic banking is also criticized on the grounds that the end results of Islamic bankingoperations are the same as those of conventional banking. Apparently, this may be true, forthe reason that IFIs are using the same benchmarks, working in a competitive environmentand, as such, are not in a position to give or charge rates significantly different from thoseof the conventional banks. The financial sector’s benchmarks make the administration andregulation by the banks’ management and the regulators easy, effective and transparent.Hence, Islamic banks generally use the benchmarks that conventional institutions use. But