CIFE Risk Management in Islamic Finance

Question 1

What unique risk categories exist in Islamic finance that do not exist in conventional banking?

Accepted Answer

Sharia non-compliance risk, displaced commercial risk, rate of return risk, and inventory/ownership risk from asset-based transactions

Answer

Islamic finance has fewer risks

Answer

Only credit risk is unique

Answer

Islamic finance has the same risks as conventional banking

Question 2

What is displaced commercial risk (DCR) in Islamic banking?

Accepted Answer

The risk that an Islamic bank may forgo its profit share to pay competitive returns to investment account holders, preventing deposit withdrawal

Answer

Risk of commercial property damage

Answer

Risk of currency fluctuations

Answer

Risk of regulatory changes

Question 3

What is the Profit Equalization Reserve (PER) in Islamic banking?

Accepted Answer

A reserve created from investment income to smooth returns to investment account holders across periods, reducing displaced commercial risk

Answer

A regulatory capital reserve

Answer

A reserve for bad debts

Answer

A tax provision

Question 4

How does credit risk management differ in Islamic banking compared to conventional banking?

Accepted Answer

Islamic banks face additional credit risk from the asset-based nature of transactions — they own assets before selling/leasing, creating inventory and price risk

Answer

Credit risk is the same in both

Answer

Islamic banks have no credit risk

Answer

Credit risk is lower in Islamic banking

Question 5

What is rate of return risk for Islamic investment accounts?

Accepted Answer

The risk that the actual return on Islamic investment accounts will be lower than expected or lower than what conventional banks offer, leading to fund withdrawals

Answer

The same as interest rate risk in conventional banking

Answer

There is no rate of return risk

Answer

Only applicable to Sukuk

Question 6

What liquidity risk management tools are available to Islamic banks?

Accepted Answer

Government Sukuk, commodity Murabaha transactions, Islamic interbank placements (Wakala/Mudaraba), and IILM short-term Sukuk

Answer

Only holding cash reserves

Answer

Islamic banks use conventional money markets for liquidity

Answer

No specific liquidity tools exist