Tutorial 8 & 9

BFI200 ISLAMIC FINANCIAL MARKETS AND INSTITUTIONS

TRUE AND FALSE QUESTIONS

Risk management from Islamic Perspective

1. Despite the fact that excessive risk is prohibited in Islam, Islamic finance links
profits with risks.
2. A number of the Islamic finance products are inherently prone to risks.
3. Unlike their conventional counterparts, Islamic banks are protected from business
risks.
4. The risks faced by the Islamic banking industry are the same as the normal risks of
the banking industry.
5. In addition to the risks faced by conventional banks, Islamic banks also face risks
associated with the compliance with the Sharī'ah in Islamic finance transactions.

6. Only debt-based transactions in Islam finance are associated with risk.

7. The criterion of legality of any return on capital investment is risk

8. The Islamic banks and financial institutions have utilized the conventional risk
management techniques prior to the development of Sharī'ah-oriented framework for
risk management.

9. There is no need for special guiding principles specifically designed to cater for the
needs of institutions offering Islamic financial services since all issues are of equal
importance to all financial institutions across the world.

10. Combining risk and profit in Islamic commercial transactions might imply the
mismanagement of funds.

11. Once Islamic banks and financial institutions decide to lend or extend financing
facilities, then they would have exposure to credit risk.

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12. Failure to repay the debt within the time stipulated in the contract and in line with
the terms of the contract constitutes a liquidity risk for the bank.

13. The potential default of a bank’s customer to meet his or her obligations on agreed
terms constitute a credit risk for a bank.

14. One of the IFSB guiding principles for the management of credit risk for Islamic
banks and financial institutions stipulates that the “IIFS shall have in place a general
Sharī'ah-compliant credit risk mitigating technique appropriate for all Islamic
financing instruments”.

15. Counterparties are retailers/consumers, corporate, or sovereign clients of the bank

who obtain credit facilities based on agreed terms and conditions.

16. Due diligence review includes the ascertainment of the eligible counterparties of the
IIFS through a comprehensive assessment of their individual risk profiles.
17. The due diligence process must follow the granting of any type of financing for the
counterparties.

18. The creditworthiness of the counterparties as well as the Sharī'ah compliance of

newly proposed business projects should be properly reviewed and established once
the credit has been approved to respective party.
19. Each Islamic financial instrument must have its unique Sharī’ah-compliant credit
risk mitigating technique.
20. Equity investment in unlisted companies refers to the acquisition of equity (or
ownership) participation in a joint venture company or a start-up.

21. Equity investment in listed companies is considered to be of higher risk than for
venture capital investment. .

22. The relationship between the IIFS and Investment Account Holders (IAH) is a
fiduciary relationship.

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23. IFSB guiding principles on equity investment risk require the IIFS to define and
establish the exit strategies in respect of their equity investment activities, subject to
the approval of the institution’s Sharī'ah board.

24. According to IFSB-1, market risk is defined as the risk of losses in on-balance sheet
positions arising from movements in market prices.

25. Restricted investment accounts are account portfolios where the account holders
fully authorize the Islamic bank to invest their funds in profitable business ventures.

26. Rate of return risk is defined as the risk associated with the overall balance sheet
exposures where there is a mismatch between the assets and balances from fund
providers.

27. IFSB-1 does not differentiate between the rate of return risk and the interest rate risk
since both risks cannot be exactly pre-determined.

28. It is strategic for the IIFS to retain their fund providers to avoid insolvency and an
ultimate liquidation.

29. An Investment Risk Reserve (IRR) is the amount appropriated from income to the
IAH before the share of the investment manager (Muḍārib) is allocated.

30. The IIFS are discouraged from using balance sheet techniques to minimize exposure
to risks.

31. Islamic promissory forward contract (IPFC) which is structured in a manner that
reflects the concept of wa’d (promise) is used as a tool for risk management in
Islamic financial transactions.

32. The binding nature of wa’d is limited to murabahah transactions.

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 33. Islamic swaps are different from the conventional swaps in that Islamic swaps are
linked to asset-backed transactions such as ijarah, murabahah, and bai bithaman
ajil.

34. Both FX Forward and FX Swap involves a two-stage contract where there is an
initial exchange at the beginning of the process and subsequently another exchange
takes place at the expiration of the contract.

35. ICCS stands for Islamic Cross Country Swap.

36. Islamic Cross Currency Swap (ICCS) allows the Islamic banks to hedge the interest
and currency exchange risks of their investments in foreign denominated assets.

Multiple Choices Questions

1. The Islamic Financial Services Board (IFSB) issued the Guiding Principles of
Risk Management for Institutions which:
a) offers both conventional and Islamic financial services (other than Insurance
Institutions)
b) offers only Insurance Services
c) offers only Islamic Financial Services (other than Insurance Institutions)
d) offers only retakaful services
2. The non-financial risks that Islamic banks are exposed to include:
a) operational risk
b) legal or Sharī'ah risk
c) reputation risk
d) all of the above

3. _________________ is the risk encountered in business transactions when there is

the potential for default on the part of the counterparty in meeting its obligations as
agreed in an underlying contract
a) rate of return risk
b) credit risk
c) market risk
d) liquidity risk

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4. The IFSB guiding principles on equity investment risk management stipulate that
IIFS shall
a) ensure that their profit sharing methods are appropriate and consistent,
b) have in place appropriate strategies for risk management and adequate reporting
processes.
c) define the fiduciary relationship between the contracting parties.
d) all of the above
e) none of the above

5. __________________ is also known as systematic risk

a) credit risk
b) liquidity
c) market risk
d) operational risk

6. In some cases, market risk in a lease contract may arise from the:
a) default of payment on the part of the lessee due to price variation
b) default on the asset delivery by the bank/lessor
c) termination of the lease by the lessee earlier than the contractual term either
through default in payment or due to some other factors
d) All of the above

7.__________________ is a commodity sale involving an advance payment where

the delivery of the commodity is deferred.
a) Ijarah contract
b) murabahah contract
c) salam contract
d) restricted investment contract

8. Ijārah Muntahia Bittamlik is a form of lease contract that offers the lessee an option
to own the asset at the end of the lease period by:
a) purchasing the asset at cost value
b) payment of the market value
c) by means of a special Ijārah contract
d) all of the above
e) none of the above

9.Risk transfer involves:

a) the use of derivatives for hedging

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 b) changing borrowing terms and selling or buying of financial claims
c) excluding all elements of uncertainties (gharar) and interest (riba) from the
contract
d) a and b

10.The Sharī'ah-compliant risk transfer mitigation techniques developed by experts in

the Islamic finance industry include:
a) swaps such as debt-asset swap, swap of liabilities, deposit swap.
b) options include parallel contracts, such as bay al-arbun
c) futures include salam and commodity
d) all of the above

11.____________________ is a continuous supply–purchase relationship with known but

deferred price and object of sale
a) bai al-urbun
b) bai al-tawrid
c) bai bithaman ajil
d) bai al-salam

12. Derivatives are:

a) financial instruments or securities whose value depend upon or derived from one
or more underlying assets, or from the value of a rate or index of asset value.
b) proactive business positions intended to reduce the impact of potential loss that
may be incurred by a companion investment.
c) contingency plans in order to effectively mitigate instances of liquidity risk.
d) none of the above

13. Which of the following statements regarding Islamic Foreign Exchange (FX) Swap is
invalid?
a) FX is contract that has been designed as an Islamic hedging mechanism to
minimize the exposure of market participants to the volatile and fluctuating market
currency exchange rate
b) FX forward contract is only a one-stage contract that only requires the initial
exchange and that concludes the contract
c) FX swap is meant to protect the financial institutions from fluctuating borrowing
rates
d) FX Swap involves a two-stage contract where there is an initial exchange at the
beginning and subsequently another exchange takes place at the expiration of the
contract
SHORT ANSWER QUESTIONS

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Question 1
Define risk and risk management. How are the two concepts related?

Question 2
Describe the nature of credit risk.

Question 3
What are the main causes of operational risk?

Question 4
What is the meaning of equity investment risk ?

Question 5
Explain the IFSB guiding principles on Equity Investment Risk

Question 6
Describe the three approaches to hedging.

Question 7
Identify the key functions of the Islamic cross currency swap (ICCS)

Question 8
Explain the six major risks faced by Islamic banks and financial institutions.

Question 9
What do you understand as the Islamic profit rate swap (IPRS)?