FINANCIAL RISK MANAGEMENT FOR ISLAMIC BANKING AND FINANCE

Palgrave Macmillan Finance and Capital Markets SeriesFor information about other titles in this series please visit the website:http://www.palgrave.com/business/financeandcapitalmarkets.asp

Financial RiskManagement for

Islamic Banking andFinance

IOANNIS AKKIZIDIS AND

SUNIL KUMAR KHANDELWAL

© Dr. Ioannis Akkizidis and Dr. Sunil Kumar Khandelwal 2008First Foreword © Agil Natt 2008Second Foreword © Amgad S. Younes 2008

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Transferred to Digital Printing in 2011

ISBN 978-1-349-36366-7 ISBN 978-0-230-59875-1 (eBook)DOI 10.1057/9780230598751

Softcover reprint of the hardcover 1st edition 2008 978-0-230-55381-1

Other books by Ioannis Akkizidis

1. Guide to Optimal Operational Risk & Basel-II, 2006, Auerbach Publications / Taylor &Francis, Boca Raton / New York, ISBN: 0849338131.

2. Integrating Market, Credit and Operational Risk: A Complete Guide for Bankers & RiskProfessionals, 2006, Risk Books, London, ISBN: 1904339964.

Apart from its manuscript, the first book also includes a practical operational risk softwaretool for designing and evaluating an operational risk management framework based onadvanced measurement approaches.

The second book is a best seller. Its Chapter 3 ‘Operational Risk’ and Chapter 4 ‘ExtremeValue Theory in Risk Management’ are listed from the GARP Association as recommendedmaterial for 2007 FRM Study Guide Readings. For more information please visit:

https://www.garpdigitallibrary.org/display/booktitle.asp?btid=161

This book is dedicated to:

‘My Father’(Dr. Ioannis Akkizidis)

‘My Larger Family’(Dr. Sunil Kumar)

vii

Contents

CHAPTER

List of Tables x

List of Figures xii

Foreword by Agil Natt xiv

Foreword by Amgad S. Younes xvi

Preface xviii

About the Authors xxiv

Acknowledgements xxvi

Abbreviations xxviii

1 Principles of Islamic Finance 1Introduction 1

2 Risk Management Issues in Islamic Financial Contracts 28Introduction 28An overview of financial risks 30Identifying risks in Islamic finance 36Risk of non-compliance with Shariah rules 41Main elements used in financial risk analysis 41Mushãrakah contracts of partnership and financial risks 42Mudãrabah contracts of partnership 49Murãbaha contract agreements and financial risk 54Salam contract agreements and financial risk 58Istisnã contracts and financial risks 63Ijãrah contract agreement and financial risk 68

3 Basel II and IFSB for Islamic Financial Risk 80Introduction 80The Basel accord 82Risk management according to Basel II and the Islamic financial industry 83

The three pillars of Basel II 84Pillar 2: Supervisory review 96Pillar 3: Market discipline 98IFSB principles of risk management 99

4 Credit Risks in Islamic Finance 109Introduction 109Credit risk exposure identification 110Credit risk assessment models 113Credit risk valuation 118Credit risk mitigation 133Credit rating systems 134Validating the credit rating systems 139

5 Market Risks in Islamic Finance 148Introduction 148Identification of market risk factors 149Rate of return risk 149Commodity risk in Islamic finance 154FX rate risks 159Equity price risks 160Valuation issues on equity prices and FX rates 160Quantification of foreign exchange risk, equity risk, and commodity risk 161Data referring to market risk factors 161Sensitivity in market risk 163Market risk valuation models 164VaR models for Islamic financial contracts 164Position and market data 166Position risk and exposure risk 168Evaluation methods of market risk 168Variance–co-variance method 169Monte Carlo simulation method 173Historical simulation 174Back-testing and stress-testing for market risk exposures 176

CONTENTSviii

6 Operational Risk in Islamic Finance 182Introduction 182Main elements in operational risk analysis 183Identification of operational risk 185Measuring operational risks 197Loss events 199Evaluating operational risk based on VaR analysis 203Elements in the framework of the operational risk management 206

7 Concluding Remarks 211

Index 217

CONTENTS ix

x

List of Tables

1.1 Differences between conventional financing and Islamic financing 3

1.2 Typical balance sheet of an Islamic bank 101.3 Differences between Mushãrakah and Mudãrabah 171.4 Top 10 Sukûk until February 2007 based on size 252.1 Risks in Islamic financial services 392.2 Comparative information requirements –

conventional vs Islamic banks 402.3 Pattern of risks where financial institutions are

exposed by applying Islamic financial contracts 733.1 Alternative approaches to credit, market, and

operational risk 873.2 Template for the calculation of the credit risk

exposures as per Pillar 1 under Basel II 913.3 Detailed loss event type classification 933.4 Beta factors for the different business lines 943.5 The IFSB guidelines on risk management 1004.1 Different cases for estimating the probability of

default based on quantitative criteria 1234.2 Classification of the levels of credit ratings with

the indication of the creditability and the reliability as well as the meaning in terms of exposure 137

5.1 Factors that initiate commodity risk in Islamic financial contracts 158

5.2 Advantages and drawbacks by applying Historic,Monte Carlo, and Variance–Co-variance Methods 175

5.3 The three zone ‘traffic light’ for the overshooting and the multiplier factor 177

6.1 Examples of types of operational causes, events and,consequences 188

6.2 Sources of operational risks 190

LIST OF TABLES xi

1.1 Structure of Islamic financial service industry 42.1 Major types of risks in the financial industry 322.2 Information management in organisations 352.3 Risk profiling – conventional vs Islamic banks 382.4 Main elements considered in financial risk analysis 422.5 Structure of Mushãrakah partnership joint venture

contract agreements 432.6 Credit, operational, market, and liquidity risks during

the lifetime of Permanent Mushãrakah contracts 452.7 Credit, operational, market, and liquidity risks

during the lifetime of Diminishing Mushãrakah contracts 462.8 Ownership pattern and risk in Mushãrakah contracts 482.9 Structure of Mudãrabah contract agreements 492.10 Risks in Mudãrabah contract agreements during

the investment period 512.11 Risks in Mudãrabah contract agreements during

the business profitability and loss period 522.12 Murãbaha structure and its main interrelations 552.13 Credit, operational, and market risks during the

lifetime of a Murãbaha contract 562.14 Relation structure in Salam contract agreements 592.15 Operational, credit, market, and liquidity risks during

the lifetime of Salam contracts 612.16 Relation structure in Istisnã contract agreements 632.17 Operational, credit, market, and liquidity risks during

the lifetime of Istisnã contracts 662.18 Ijãrah contract agreements 692.19 Credit, operational, and market risks during the

lifetime of Ijãrah contracts 71

xii

List of Figures

3.1 The three pillars of Basel II accord 854.1 Relations between the Islamic financial counterparties

and contracts and the guaranties and collaterals 1104.2 Representation of the links between a counterparty

with several contracts and risk coverage by several guaranties and collaterals 112

4.3 Model layout of the expert system for credit risk assessment 115

4.4 Distribution of expected and unexpected losses in credit risk 128

4.5 Periods and samples used for the rating valuation 1435.1 The four types of market risks that exist in the

different Islamic financial products 1505.2 Interaction and relation between commodity

risk in Islamic finance with other commodity risk factors 1555.3 Flow chart referring to the Value-at-Risk approach 1655.4 Main components considered in VaR models 1665.5 Normal distribution of the changes caused by the

value of a market analysis portfolio 1696.1 Operational risk analysis based on operational risks

and losses 1836.2 Main approaches in operational risk

identification analysis 1846.3 Sources of operational risks and where they

affect Islamic financial contracts 1946.4 Interactions among the different causes of

operational risks 1976.5 The three approaches used to cultivate and

populate the loss event databases 2026.6 Loss distribution for operational risk 203

LIST OF FIGURES xiii

I congratulate the authors Messrs Akkizidis and Khandelwal for writing thisbook, Financial Risk Management for Islamic Banking and Finance. Therehave been many books written on Islamic banking and finance, but few havebeen written on risk management aspects, especially within the context offinancial products which are Shariah-compliant. I find the book compre-hensive in its approach and detailed in information which will render it as avaluable reference material for practitioners and students alike. The bookstarts with an introduction of various products and services that arecurrently being marketed and then discusses the various risk managementissues in Islamic financial contracts. It also discusses on the IFSB principlesof risk management and Basel II. The authors have also provided variousmethodologies and logical steps involving mathematical models to identifyand measure risks in Islamic finance.

The publication of this book will be greatly welcomed by industryplayers and students. Both authors are well versed in this subject and havedone extensive research to write this book, which covers all practical andtheoretical concepts of financial risk management pertinent to the Islamicfinancial services industry. The growth in the Islamic financial servicesindustry has been phenomenal in the last two decades and has formed thebasis of a viable alternative system which in some aspects has rivalled itsconventional counterpart. Today, we see traditional financial capitals ofthe West joining the race with the new entrants of the East in laying andexpanding the infrastructure for a robust Islamic financial system. Yet, thenumber of knowledgeable Shariah financial practitioners is still trailingbehind. Against this background, institutions like INCEIF have mappedout their global agenda of developing competent financial practitioners toserve the global market. The challenge for the future will be to bridge thegap between the theories propounded by academia and the practical

xiv

Foreword by Agil Natt

activities of the industry and ultimately, to further enhance Islamicbanking and finance into a prime mobiliser of resources for the bettermentof mankind.

I believe this book will be able to spur further thoughts and research withthe objective of adding to this new and exciting body of knowledge.

Agil NattPresident and Chief Executive

INCEIF – The Global University in Islamic FinanceKuala Lumpur

FOREWORD BY AGIL NATT xv

The financial industry today has evolved itself to be one of the mostcompetitive, stringent, diverse, and aggressive environments to operate in.Successful financial institutions are acquiring, consolidating, and increas-ing market share, expanding product offerings and offering innovativestructures and services across multi-diverse portfolios. However, thecomplexities of risk management threaten to limit growth. The Basel IIaccord aggravates the challenges by mandating that all risk-related deci-sions and processes be fully tracked and analysed to support enterprise riskmanagement requirements.

Traditionally, risk management was based on risks to financial assets andpeople as a function, but risk management has evolved and become lessabout managing the present and more about being proactive in tacklingscenarios and achieving business excellence.

With the Basel II accord, being transparent to all conventional financialinstitutions, Islamic banks thrive for compliancy in the era of modern anddiversified financial management. With the majority of risks remaining thesame (Credit Risk, Market Risk, Liquidity Risk, Rate of Return Risk,Operational Risk, etc.), it is crucial for Islamic banks to recognise andevaluate the overlapping nature and transformation of risks that existbetween and amongst the categories of risks. Adverse changes in theIslamic banking market, counterparties, or products, as well as changes inthe economic and political environments in which they operate and theeffects of different Shariah rulings, are examples of Business Risks; in thisregard, Islamic banks are expected to view the management of these risksfrom a holistic perspective.

This book is a welcome attempt to help Islamic banking and financereaders to broaden their horizons and enlighten their understanding towardsRisk Management with a new perspective. The objective remains simple:

xvi

Foreword by Amgad S. Younes

FOREWORD BY AMGAD S. YOUNES xvii

‘Risk Management remains to be of crucial importance in today’s modernconglomerates.’ I do believe that this book will become an invaluablereference point to all those senior executives, risk managers and practition-ers, researchers and students.

AMGAD S. YOUNES

Senior Vice-PresidentHead of Financial Control,

St. Planning and Total Risk ManagementAbu Dhabi Islamic Bank

Abu Dhabi, United Arab Emirates

Nowadays, in European, American and most Westernised markets, financialinstitutions such as Credit Swiss, Deutsche Bank, HSBC, the Islamic Bankof Britain, etc., are offering more products and services for Islamic finance(it is estimated that only Arab investors have more than US$800 billion ondeposit in overseas banks, much of which is secured in Swiss and Europeanbanks). Moreover, a great number of financial institutions in GCC (Gulf Co-operation Council) countries and Asia are managing funds of overUS$300 billion and are encouraged from their markets to provide Islamicfinancial products. The Asia-Pacific region houses the most populousIslamic nation on earth, approximately 800 million. As a result of thegrowth market of Islamic finance, the demand for risk management forIslamic financial products and services is becoming a very critical issue forboth Westernised and Islamic financial markets.

In addition to what Westernised (non-Islamic) finance is providing,Islamic banks are providing specific financial products (contracts) whichmake them perform as investors, instead of only as creditors. Theseproducts are based on principles that are driven by Profit and Loss (P&L)sharing policies. Both the structure of all Islamic financial contracts andthe P&L policies need to fully comply with Shariah (Islamic) laws.Additionally, Islamic financial institutions and also Westernised institu-tions that provide Islamic products (via Islamic windows) are on the roadto complying with the Basel II accord. Thus, they are facing thechallenge of developing internal models in order to quantify, supervise,and manage all three major types of their financial risks; that is, credit,market, and operational risks. Moreover, they need to provide adequatesolutions and define the associated minimum requirements for the super-visory regime.

This book covers all risk management issues for all Islamic financialproducts and services, including Mushãrakah, Mudãrabah, Murãbaha,

xviii

Preface

Salam, Ijãrah, and Istisnã, considering all of their unique characteristicsthat are underlined by the Shariah principles and law.

Therefore, the book provides an overview of the systematic methodolog-ical steps for evaluating and managing all types of financial risks for theIslamic financial products. It describes all types of risks and addresses theissue of how to identify both qualitatively and quantitatively their signifi-cance levels. Moreover, the book shows how to define when the risks appearwithin the lifetime of the different types of contracts. Measurementtechniques for quantitatively assessing all types of risks are also describedin this book.

Additionally, the book demonstrates the methodologies to model andevaluate financially, using mathematical approaches, the risks in the con-tracts referring to Islamic finance. The overall effects of risks includingtheir impact on the bank’s profit-and-loss and asset and liability on the bal-ance sheets are also discussed. Hence, all risks that are initiated from thefluctuations of the balance sheet and the sharing (PLS) and non-sharing(P&L) profit-and-loss financial products is fully explained in this book.Risk management for Islamic banking financial products and services is oneof the greatest challenges that many Westernised as well as Islamic banksare facing and probably will continue to face in the future. Therefore, thisbook is a valuable guide for those that are working on both conventional(non-Islamic) and Islamic finance.

ORGANISATION OF THE BOOK

The book is divided into 7 chapters, consisting of different sections:

Chapter 1: Principles of Islamic Finance

Chapter 1 begins with an overview of Islamic financial principles. Thereasons for the advent of Islamic finance can be traced to social and ethicaldimensions of the financing. The role of Shariah and other classical Islamicschools of thought in Islamic finance is discussed in this chapter.Prohibition of Riba, avoidance of Gharar and Haram activities, andpayment of Zakat are important cornerstones of Islamic finance and areintroduced in chapter 1. Additionally, major differences between conven-tional and Islamic finance are also presented. The chapter further covers sig-nificant areas of Islamic finance, such as accounting standards, internationalrisk management framework, and the growth of the industry. Accounting inIslamic finance is not the same as conventional finance and a glimpse at atypical Balance Sheet of an Islamic bank reveals some of the differences.Moreover, the chapter explains the treatment of assets and liabilities as

PREFACE xix

needed in Islamic accounting. One of the fundamental tenets of Islamicfinance is the participation in the business activity and avoidance of a purefinancial debt. Profit and Loss Sharing (PLS) contracts are a result of this.The relevance of PLS contracts in Islamic finance is explained in this chap-ter, along with the reasons for their limited use. Six most common types ofIslamic financial contracts are identified as relevant in the current state ofthe progress of Islamic finance. Mushãrakah, Mudãrabah, Murãbaha,Salam, Istisnã, and Ijãrah are the most commonly used Islamic financialcontracts and have been selected for further analysis in this chapter. Thechapter deals with Mushãrakah and Mudãrabah as investment contracts andexplains them in detail with the help of examples drawn from real-life activ-ities of Islamic banks. Permanent and Diminishing Mushãrakah, along withdifferences between Mushãrakah and Mudãrabah, are analysed in thischapter. Furthermore, the chapter, with the help of supportive examples,deals with the most popular Islamic contract form, Murãbaha. Further,Salam and Istisnã as vehicles for forward sale are discussed and examplesare presented to demonstrate their applicability. Being very similar but notthe same, the two are differentiated on the basis of fundamental points.Ijãrah, the Islamic leasing, is also dealt with in this chapter. Bonds inIslamic finance, known as Sukûk, are a recent phenomenon. The market forSukûk has been growing rapidly, with several large Sukûk being issuedrecently. This chapter also presents an analysis of Sukûk.

Chapter 2: Risk Management Issues in Islamic Financial Contracts

In chapter 2, a brief overview of financial risks is presented, along with adetailed risk profiling of Islamic financial contracts (Mushãrakah,Mudãrabah, Murãbaha, Salam, Ijãrah, and Istisnã), for the existence of thedifferent types of financial risks; that is, credit, market, operational, liquid-ity. Examples, with detailed graphical timeline analyses of the contract life,are provided to support the reader’s understanding of the risks inherentwithin the different financial contracts. An overview of risks in Islamicfinance is explained, along with a comparison with conventional finance. Itshows that all discussed Islamic financial contracts are exposed to opera-tional risks. Likewise, credit risks appear in all contracts except in theSalam and Istisnã contracts. Moreover, it demonstrates that all contractsthat are dealing with commodities � that is, Murãbaha, Ijãrah, Salam, andIstisnã � are exposing the financial institutions to commodity price risk; onthe other hand, the Mushãrakah, Mudãrabah contracts, which are partner-ship agreements, are initiating equity risks. Some of the Islamic financialcontracts are typical due to the changing relationship between the contract-ing parties over the time period of the contract. Chapter 2 further discusses

PREFACExx

in detail, with the help of graphs, the several overlapping risks which canarise out of single events; for example, in the case of DiminishingMushãrakah, an interruption of regular cash flows to the institution cancause credit and liquidity risks. Furthermore, the chapter also presents riskmanagement strategies for the Mushãrakah, Mudãrabah, Murãbaha,Salam, Istisnã, and Ijãrah in relation to credit risk, market risk, operationalrisk, and the resulted liquidity risk. This chapter is a useful guide to identi-fying for all the existing as well as future types of Islamic financial contractsthe different types of risks that may arise within their lifetime. This ismainly based on the evaluation of the associated financial events linked tothe expected inflow-cash and outflow-cash flows.

Chapter 3: Basel II and IFSB for Islamic Financial Risk

Chapter 3 provides all necessary information needed for banks that provideIslamic financial products, to comply with the Basel II accord. Islamicfinancial contracts are typified by the changing relationship between thecontracting parties during the lifetime of the contracts. This has a directbearing on the risk exposures. This chapter highlights the detailed analysisof credit, market, and operational risks that has been given by the Basel IIaccord. The three mutually-enforcing Pillars are the foundation of Basel IIand this chapter discusses the applicability of these pillars in Islamic finan-cial industry. It highlights that Basel II is primarily for conventional banksand thus is not fully relevant to Islamic financial institutions. However, inline with any other industry guidelines, some of the principles of risk man-agement as proposed in Basel II are applicable to Islamic financial industryas well. The basic role of capital cannot be changed and thus the role of riskmanagement in any institution. Further, the chapter analyses the variousapproaches presented under Pillar 1 along with their relevance to theIslamic financial industry. Pillar 2 and Pillar 3 are supportive in nature andhence their role in risk management is more at a supervisory level, whichhas been presented in this chapter. The chapter also signifies the linkbetween the role of social responsibility of Islamic finance and market dis-closure. The chapter further identifies that the IFSB is playing a key role inthe development of standards for risk management in the Islamic financialindustry. The recent release of standards for risk management is the firstsystematic attempt at consolidating the efforts for bringing Islamic financialrisk management under one umbrella, and this is discussed. The six majorrisks as identified by the IFSB for the Islamic financial industry � credit,market, operational, equity investment, liquidity, and rate of return � areexplained in this chapter. Furthermore, the suggested treatment for theseaccording to the IFSB is also analysed.

PREFACE xxi

Chapter 4: Credit Risks in Islamic Finance

In chapter 4, the risks of credit defaults referring to counterparties,collaterals, and guarantees are fully covered for all Islamic types of finan-cial contracts. As discussed in this chapter, financial institutions are exposedto credit risks that correspond to lending in the Murãbaha, leasing in theIjãrah, promises to deliver or to buy in Istisnã and Salam, and investmentsfailure in the Mushãrakah and Mudãrabah contracts. Furthermore, thechapter identifies different methods and techniques for developing modelsfor credit risk that results from Islamic products. The chapter also highlightscredit value-at-risk (VaR) based on expected and unexpected losses. TheCredit VaR estimation is viewed as the economic capital to be held as abuffer against unexpected losses. The chapter also discusses how financialinstitutions are mitigating credit risks by employing collaterals or guaranteesgranted by tier counterparties.

Chapter 5: Market Risks in Islamic Finance

Chapter 5 discusses how Islamic financial institutions are exposed to marketrisk primarily through four types of risks, which are: rate of return (mark-up) or benchmark rate risks related to market inflations and ‘interest rates’,commodity price risks as they typically carry inventory items (predefinedprices), FX rate risks in the same way as conventional banks and equityprice risks mainly in regards to the equity financing through the profit andloss sharing contract modes. Islamic financial products carry more than onemarket risk factor; moreover, even a simple portfolio usually contains dif-ferent types of contracts. This combination of risk factors and contractsincreases the complexity of collecting and combining the informationneeded for market risk analysis. As discussed in this chapter, the sensitivityto market risk in Islamic contracts reflects the relationship between thecause from a financial risk factor and its adverse impact to the financialinstitution’s earnings from these contracts. In financial analysis, the mostprominent techniques to valuate market risks are the value-at-risk (VaR),and this analysis is outlined in this chapter.

Chapter 6: Operational Risks in Islamic Finance

In chapter 6, operational risk, one of the major topics in today’s financialrisk management, is discussed. The chapter presents all the key aspects ofoperational risk management by giving guidelines on how to identify andqualitatively map risks in operations within all the business lines as well ashow to transfer their qualitative attributes to quantitative measurementindicators. It outlines some of the initial main elements of operational risk

PREFACExxii

CHAPTER TITLE xxiii

analysis, which includes the identification, mapping, assessment, andmeasurement and evaluation. It particularly makes reference to Islamicfinancial products and especially the compliance with the Shariahprinciples and laws. Three different approaches for operational risk identi-fication analysis are presented: the self-assessment analysis, the quantitativeoperational risk indicator approach, and the operational risk loss approach.The chapter further discusses the identification factors and operational riskmapping. It particularly goes deeper into the identification of operationalrisk causes, events, and consequences. It graphically illustrates the differentsources of operational risks with regard to the different Islamic financialcontracts. It talks about how the loss data collection is a primary approachfor the assessment of operational risks. The issue of IT security is particu-larly highlighted. It also underlines that in some cases the operational risksrelated to IT systems/technologies have a significant impact and can evenlead to credit and market risk.

Chapter 7: Concluding Remarks

Concluding remarks are provided in chapter 7. This chapter brings togetherall the issues and ideas discussed throughout the book. A brief summary ofthe important conclusions is also presented in this chapter. It discussesfuture directions of financial risk management in Islamic Banking andFinance.

References are given at the end of every chapter for those interested instrengthening their knowledge beyond the material and scope of this book.All referenced documents written by the Basel Committee on BankingSupervision are available free of charge from their websitewww.bis.org/bcbs/publ.htm and documents from the IFSB can be found onhttp://www.ifsb.org

A list of acronyms is finally given to ease understanding of the termsused throughout the book.

Dr Ioannis Akkizidis is a Risk Management Consultant & Analyst at IRISIntegrated Risk Management AG, Zürich, Switzerland. Ioannis is a mainauthor of the bestselling book entitled Integrating Market, Credit andOperational Risk: A Complete Guide for Bankers & Risk Professionals(2006), where two of its chapters are part of the recommended material forthe GARP’s 2007 FRM Study Guide. He is also the main author of the bookentitled Guide to Optimal Operational Risk & Basel II (2006). His firstdegree is in engineering (in Athens, Greece), whereas his postgraduatemasters degree is in applied mathematical analysis and control systemsfrom the University of Portsmouth, England, UK. He holds a PhD in appliedmathematics and artificial intelligence obtained from the University ofWales, UK. He has published several scientific papers in internationaljournals and presented at international conferences and events, giving talkson the subject of Financial Risk Management including Islamic Finance. Hehas work experience worldwide over many years in risk management andhis main interests lie in designing and implementing models as well asbringing new ideas in the risk and financial management field for financialinstitutions and large corporations.

Dr Sunil Kumar Khandelwal is Head of Risk Management – Middle East –at IRIS integrated risk management ag, Dubai, United Arab Emirates. He ismainly responsible for providing strategic direction to organisational activities.He specialises in Basel II, Operational Risk and Islamic Finance. His interestsare also in e-banking, and e-commerce. He holds an MBA in Finance fromThe University of Southern Queensland, Australia. He has a PhD in appliedIT (Banking & Finance) from The Indian Institute of Technology, Bombay.He is providing research support to banks for risk management and Basel II.He was the Chief Strategist and Architect of the e-services for the Ministryof Health, UAE. He has delivered several talks, discussions, and speeches

xxiv

About the Authors

CHAPTER

ABOUT THE AUTHORS xxv

on banking and finance. He has also chaired numerous sessions in roundtables and meetings on finance. He has several articles to his credit injournals, newspapers, and magazines. He is an active member of GARP andISACA in UAE. He has been actively involved in several co-operativeactivities of the financial industry in UAE.

ContactsThe authors will be pleased to have feedback and are open to any discussionreferring to the subject and material presented in this book. Please contactthem via e-mail and/or postal address on:Dr Ioannis Akkizidisioannis.akkizidis@iris.chioannis.akkizidis@irisunified.comIRIS integrated risk management agBederstrasse 1, CH-8027 Zürich, SwitzerlandDr Sunil Kumarsunil.kumar@irisunified.comIRIS integrated risk management agDubai, United Arab Emirates.

The authors would like to specially thank all those who gave them supportin different ways for the completion of this book. Ioannis Akkizidis wouldlike to thank the members of IRIS Integrated Risk Management AG for thevaluable participation in discussions, feedback, and bringing ideas forimproving the quality of this book; special thanks to Mr Jäk Andreas forencouraging him to write this book and for his valuable comments on itstext. Thanks also to Ms Kathy Cleemput for her useful feedback on the textof the book and Mr Nikolaj Tsenov for putting the idea in my mind for writ-ing a book on this topic. Many and special thanks go to Dr VivianneBouchereau for the proof-reading of the manuscript and also for her smallcontributions in the material of this book. Her work and contribution playeda key role in the quality of this book. Also, many thanks go to Mr NikosAkkizidis for his helpful ideas and discussions in many financial and riskmanagement aspects; his knowledge and ideas are always more thanvaluable.

Sunil Kumar is thankful to Ioannis Akkizidis for taking up and leadingthe tasks of this wonderful book. He is thankful to Prof. L. M. Bhole,Professor Emeritus at The Indian Institute of Technology for going throughthe chapters carefully and suggesting improvements. Special thanks to MsSujata for maintaining the time schedule and ascertaining the scheduleddelivery of the contents of the book. Special thanks to Dr. Mohamed SalahEldin Mudawi for providing the much-needed library support. Sunil Kumaris thankful to the large section of bankers in UAE who have regularly pro-vided inputs needed to strengthen the contents of the book. Finally, thanksfor all those who have supported directly and indirectly in this quest forknowledge.

The authors would like also to thank Palgrave Macmillan Publicationsfor giving them the opportunity to publish their work. And last, but not least,

xxvi

Acknowledgements

ACKNOWLEDGEMENTS xxvii

a great ‘thank you’ goes to all their individual families and friends for theirconstant support, encouragement, and patience; special thanks from Ioannisgoes to his mother Ms Kyriaki Akkizidou, his sister Dr. Athena Akkizidou,as well as to Mr. Vasilios Masmanidis and Mr. Christos Ventiadis for theirinitial and endless support. Sunil is thankful to his family for patiently wait-ing for their share of time.

Abbreviation ExplanationAAOIFI Accounting and Auditing Organisation

for Islamic Financial InstitutionsADB Asian Development Bank AMA Advanced Measurement ApproachBIA Basic Indicator ApproachBOT Build Operate TransferCAH Current Account HoldersCCR Counterparty Credit RiskDIB Dubai Islamic BankEAD Exposure at DefaultIDB Islamic Development BankIFSB Islamic Financial Services BoardIIFS Islamic Financial ServicesIMA Internal Model ApproachIRB Internal Rating BaseIRR Interest Rate ReturnKSA Kingdom of Saudi ArabiaLGD Loss Given DefaultLIBOR London Interbank Offered RateOIC Organisation of the Islamic ConferenceP&L Profit and LossPD Probability of DefaultPER Profit Equalisation ReservePLS Profit and Loss SharingRRR Rate or Return Risk

xxviii

Abbreviations

SA Standardised ApproachShariah Body of Islamic lawSPV Special Purpose VehicleUAE United Arab EmiratesUIAH Unrestricted Investment Account HolderVaR Value at Risk

ABBREVIATIONS xxix