MOODY'S: Need to prioritise risk management

By Habhajan Singh
Appropriate systems and infrastructure to address risk issues need to be in place to support sustainable growth for Islamic banks, says an international rating agency.
Noting that most Islamic banks' strategies try to achieve asset growth, Moody's Investors Service said that risk management should be implemented first followed by growth.
In a report released on May 11, Moody's identified various characteristics found in strategies adopted by Islamic banks that enhance their financial strength ratings, which it said included strategies that improve franchise value, risk positioning and financial fundamentals.
"While Islamic banks in different countries operate under different environments, are at different stages of development and therefore require different strategies, we can still find a set of common characteristics among their various strategies, which benefit their long-term ratings," Christine Kuo, a Moody's vice president/senior analyst and author of the report, said in a statement.
Risk management was one of the issues raised at the 6th Islamic Financial Services Board (IFSB) Summit 2009 in Singapore between May 5-8.
In a banking forum in Kuala Lumpur on May 11, HSBC Bank Malaysia Bhd deputy chairman and chief executive officer Irene M Dorner highlighted the preparedness of regulators to modulate the Islamic finance industry, particularly when it moves beyond replication of the conventional product profitsharing and risk-sharing.
"If you move into the next phase of Islamic banking, beyond the conventional products — the profitsharing, risk-sharing, and so on — I'm not sure how you can regulate that," she told the 13th Malaysian Banking Summit 2009.
The issue of regulation is closely tied to risk management.
In its report, Moody's said that when it comes to global comparisons, it is more important for Islamic banks to build strong franchises in selective markets and businesses, and to maintain sound financial profiles as opposed to big balance sheets.
The report assesses strategies adopted not just by Islamic financial institutions (IFIs), whose scope of business must comply with Shariah law, but also conventional banks which operate Shariah-compliant departments.
According to the report, while size is important — as diversification is harder when an institution is small — banks that enjoy dominant positions in smaller but more favourable markets may have a higher franchise value (which could translate into greater earnings stability) than a bigger bank with a highly price-sensitive customer base operating in a competitive market.
"It follows that it is better for Islamic banks to have a strategy that helps achieve a stronger position in a few selective markets than one which results in marginal positions in many competitive markets," adds Kuo.
The report notes that Islamic banks tend to have greater concentration in assets and liabilities compared with conventional banks, and face challenges in managing liquidity and risk due to the limited range of instruments available.
Moreover, Islamic products are less commoditised and require more tailoring and oversight leading to substantial overheads and operation risk.
"Additionally, for Islamic banks with significant exposures to equities and properties, conservative financial leverage is particularly important in view of the volatility in the values of these investments," notes Kuo.

(This story appeared in The Malaysian Reserve on May 18, 2009. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)