This final chapter summarises the main results and presents the conclusion of the book. It brings together all the findings and ideas discussed throughout this research. To reiterate, this study was undertaken with the objective of evaluating the contemporary risk management practices in Islamic banking. In meeting this broad objective, the views and opinions of the sampled Islamic banking professionals were obtained through a survey questionnaire and in-depth interviews. The results of the survey and interviews were analysed and compared with the theoretical framework and the related literature.

This chapter briefly recapitulates the salient conclusions derived from the findings of this research. In addition, it also presents the main policy and practical recommendations for enhancing risk culture and architecture in Islamic banking. Finally, the research limitations and suggested future research topics will be presented.

SUMMARY OF THE RESEARCH

As laid down in the introductory chapter (Chapter 1), the main aim of this research was to investigate the perceptions and views of professional bankers and financiers one way or another involved in the provision of Islamic financial and banking products across different regions about risk management in Islamic banking, with the objective of mapping out the various issues related to risk through the perceptions of the participants, namely bankers, financiers and scholars.

The study, hence, consists of two major sections, namely background and empirical work. The first five chapters are the foundational chapters for the next six chapters, the latter forming the empirical part of the book. The first chapter introduces the main research questions and states the research aim and objectives as well as explaining the rationale for choosing the research topic. It also briefly discusses the research hypotheses, and the selected research methodology. Chapter 2 covers, among other topics, the systemic importance of the Islamic banking industry and its potential growth. An overview of the various concepts of risk and the industry standards of risk management techniques are discussed in Chapter 3 along with the unique risks facing Islamic financial institutions (IFIs). This chapter represents the main chapter in the literature review part of the book. Chapter 4 looks at capital adequacy rules for IFIs in a financial world dominated by the Basel standards, while Chapter 5 analyses the roots of the recent financial crisis and its implications for Islamic banking by making reference to the risk management nature of the financial crisis.

The second part of the book is concerned with the empirical work and the findings thereof. Chapter 6, which is the first chapter of this part, deals with the research design and methodology. In essence, it is about the primary data collection and administration process, covering the different phases of that process and dwelling on its important aspects, such as the research questions, the hypotheses and the relevance of the selected research methodologies to the research questions. For the empirical part of the book, the primary data assembled through the use of the research methods of questionnaire surveys and in-depth interviews are utilised. Chapter 7 is the beginning of the statistical analysis of the survey questionnaire employing mainly descriptive analyses and Chi-Square tests as well as the more basic frequency and percentage tables. Chapter 8 is the main primary quantitative data analysis, presenting the findings from inferential statistical tests such as Kruskall-Wallis (K-W), factor analysis, MANOVA multivariate analysis of variance, and Chi-Square tests. This chapter, to a certain extent, answers the main research hypotheses and their sub-hypotheses, as the information presented in various sections of the chapter suggests. Chapter 9 is the qualitative analysis part in which the responses given by the interviewees are analysed through a coding analysis. However, more detailed discussion of the findings of both quantitative and qualitative analyses is handled in Chapter 10, which combines, integrates and discusses the main findings from all the empirical chapters, within the context of the existing literature, to provide a basis for an overall conclusion.

Finally, this chapter contains the conclusion and recommendations as already explained and also summarises the research findings and the proposed policy implications as well as the research limitations and further research topics.

REFLECTING ON THE RESEARCH FINDINGS

As discussed in Chapter 1, risk management in Islamic banking is one of the main issues as well as one of the most controversial. Although progress has been made across the industry over the past few years, Islamic banks still face significant challenges in relation to measuring and managing risks. At the same time, risk management is getting more attention all over the world due to the recent financial crisis. Within this context, it goes without saying that, for most IFIs, risk management presents specific challenges. The study therefore investigates the controversial question of whether Islamic banks are more or less risky than conventional banks. This research answers the identified research questions, not only based on conceptual research but more importantly using empirical evidence from the market place by focusing on the practical side of risk management in Islamic banking.

It should be noted that this research is practical doctoral research that fills the research gap regarding risk management in Islamic banking by investigating the perceptions and attitudes of different categories of Islamic banking practitioners toward the unique characteristics of risk management in Islamic banking from empirical evidence. This book fills the gap by taking the research one step further, by integrating theoretical concepts with the practical reality in a socially constructed manner through the opinions and perceptions of the participants.

Based on the findings in this study, it is obvious that Islamic banks face a number of challenges in terms of risk management. The entanglement of credit, market and operational risk in each contract type used by Islamic banks in their daily operations, as well as displaced commercial risks attached to the incentive to serve Profit-Sharing Investment Accounts (PSIA) holders with returns at least comparable to similar conventional deposits, are two of the main constraints IFIs need to cope with. In addition, as indicated by the findings in this research, in the absence of a wide pool of Shari'ah-compliant, sufficiently liquid investment vehicles (especially in fixed income), Islamic banks find it difficult to manage their balance sheet from an asset–liability management (ALM) perspective, especially liquidity and margin-rate risk.

As the findings depict, Islamic banks' funding mix tends to be imbalanced, with the dominance of deposits, PSIAs and equity making their funding profile predominantly short-term at a time when the maturity of their asset classes is widening. To mitigate nascent maturity mismatches, some IFIs have started issuing medium-term sukuk to lengthen the maturity profile of their funding, but sukuk still account for only a small portion of IFIs' total liabilities, as discussed in Chapter 3. Subordinated sukuk and hybrid instruments have not yet been used; these are more expensive funding sources and incentives to issue them are limited given the abundance of capital among most IFIs. The lack of liquidity and viable alternatives, combined with the competitive disadvantage, hamper IFIs and may even create a liquidity crisis. To overcome the shortcomings of the Islamic money market, many investment banks are currently designing complex new products, compliant with Shari'ah requirements. It remains to be seen whether these new solutions will obtain widespread Shari'ah-compliant status in the Islamic finance community, and generate enough demand for a functional Islamic money market to develop. To help manage their liquidity, IFIs will have to develop creative funding strategies and improve their internal capabilities to understand and forecast their liquidity needs.

In addition, the research findings identify that IFIs face other challenges from weak corporate governance practice to lack of standardisation in accounting and Shari'ah standards, and high concentration risk. In fact, IFIs show heavy concentrations across the board, by name, sector, geography and business lines.

Political risk was ignored by both questionnaire respondents and interviewees in this study; only a few respondents recognised it as a major risk affecting Islamic banking. However, the lesson from the recent political unrest and revolutions in the Middle East is that political risk matters. There is no doubt that the political and social upheaval throughout the Middle East will have direct and indirect impacts on IFIs in general and on those located in the Middle East in particular, as discussed in Chapter 10. The outflow of funds and exit of foreign investors, and the inability of governments to support Islamic banking and to bail out financial institutions remain to be assessed after the scissors effect of rising oil prices and local geo-political unrest.

The literature review reveals that Basel II was drafted with conventional banking largely in mind. Previous researchers also argue that Basel II is primarily for conventional banks and has limited applicability for Islamic banking. However, empirical evidence from this study found that market practitioners believe that with some adaptations Basel II could be applied to Islamic banks and that the Islamic Financial Services Board (IFSB) could play an important role in this context.

In brief, empirical findings from this study identified weaknesses and vulnerabilities among IFIs in the areas of risk management and governance. Risk management, monitoring, reporting and mitigation need to be upgraded across the whole Islamic banking industry. This study shows that the difficulties IFIs are currently faced with mostly stem from risk management failures, characterised by a very low degree of diversification, preference for illiquidity, an absence of financial flexibility and imbalanced funding strategies. This highlights the significance of risk management for the growth of the whole Islamic banking industry.

The findings in this research also show that although IFIs have shown resilience, they are not immune from economic shocks. Empirical evidence shows that Islamic banking is expected to emerge stronger from the crisis, provided some conditions are met, such as ‘further innovation’, ‘enhanced transparency’, ‘more robust risk management architecture and culture’, and, above all, ‘enhanced Shari'ah compliance’. Broadly speaking, Islamic banking had a relatively ‘mild crisis’ in that it suffered less damage as a result of the global economic and financial turmoil of the past few years than conventional banking. Of course there were exceptions: Dubai, with its high debt and open economy, was the main regional casualty as well as the private sectors of some other Gulf countries which were bruised as their credit bubbles popped. In general IFIs have maintained relative stability despite the global financial crisis thanks to ample liquidity, safe debts and high profit margins. However, this situation will not continue for long. Islamic banks need to reform at different levels – product, operational and institutional – to be successful. They have been lucky so far, and perhaps they will learn from the difficulties faced by conventional banks.

Many studies including this one indicate that IFIs tend to shy away from equity- and partnership-based instruments for several reasons, such as the inherent riskiness and additional costs of monitoring such investments, low appetite for risk and lack of innovation. This unwillingness to take on risk reflects the lack of transparency in the Islamic banking system, which dampens confidence and trust among investors and market participants. The result is that depositors and investors become more risk averse, and so banks become even more risk averse, thus creating a vicious circle which results in severe financial and economic crises.

The original concept of Islamic financing is undoubtedly in favour of equity participation rather than creation of debt, because it is only equity that brings an equitable and balanced distribution of wealth in society. However, the practice is very different from the theory. Practitioners of Islamic finance have to date been mimicking conventional products. This mimicking has resulted in a close correlation between the two systems. These deviations between theory and practice mean that the system is not functioning at its full potential and has adapted itself to a limited functionality. In fact, due to these deviations, the Islamic banking system is exposed to additional risks that it is not supposed to be exposed to, as explained in the previous chapters. This dichotomy between the ideals of Islamic banking morals and the realities, combined with the lack of advanced risk management and mitigation techniques, render Islamic banking more risky than the debunked conventional banking model, instead of its being a safe haven. There is a growing realisation that the long-term sustainable growth of Islamic banking will depend largely on the development of proper risk management architecture. Islamic banking could be a safe haven only when its broader principles on a macro-level are entirely followed by all participants. In other words, when short-term risks and longer-term stability are put together and optimised, the outlook for the Islamic banking industry looks less risky than its critics claim.

Islamic banking, so far, as it is being practised does not appear to be a genuine reflection of the aspirational expectations of fiqh requirements for Islamic finance. Islamic banking benefits, when measured by conventional yardsticks, do not amount to much. Therefore, IFIs and all participants in Islamic finance should strictly follow the rules of Shari'ah, regardless of whether the benefits of such rules are apparent or measurable. There is a particular logic and morality to Shari'ah principles, which Islamic banking practitioners will see only if they stop trying to shoe-horn them into conventional product structures.

Market discipline and transparency rules have been the pride of Western financial systems for decades. The irony is that those rules have consistently failed whenever tested by severe financial stress. On the other hand, more resilient and ethical rules have long existed in the roots of Shari'ah finance. Some of the previously criticised inherent constraints – imposed on Islamic banks by Shari'ah – have proved to be conservative risk management tools that enabled most Islamic banks to navigate the crisis. Limited availability of hedging tools, prohibition of derivatives and speculation, the linking of risks to assets, and extra liquidity and capital buffers are all examples of built-in principles that were criticised by opponents of Islamic banking as burdens on profitability prior to the crisis. with hindsight they proved to be important strengths that ensured stability, as explained in Chapter 5. From a risk management perspective, Shari'ah can provide a moral compass that guides risk takers as to which risks are acceptable and which are not.

RESEARCH IMPLICATIONS AND RECOMMENDATIONS

As mentioned in Chapter 1, the present study is motivated by an observation that there is a gap between the theoretical aspects of risk management in Islamic banking and the practical behaviour of industry practitioners – a fact that has been articulated by many in different formats. Therefore, the results of this study provide positive implications and recommendations for various stakeholders in pursuing the desired ultimate objectives of the Islamic banking system.

It should, furthermore, be stated that this research also contributes to the body of existing academic research in terms of opening up new areas of study; in addition, it renders valuable input to industry practitioners for improving current regulations and practice related to risk management, reporting, mitigation, capital adequacy and development strategies. The findings in this study may also prove very useful for promoting financial stability from a risk management perspective.

LIMITATIONS OF THE STUDY

There is no perfect study and the current one is no exception. There are four limitations that need to be acknowledged and addressed regarding the present study. First, the cultural aspects of risk management and the impact of regional cultural differences on the risk perception of respondents should have been examined. Each region has its unique culture which shapes its risk management and therefore Islamic finance-related studies should also endogenise the cultural and cultural–religious dimension of risk in considering risk and risk management practices. It is hoped that such a study could be conducted in the future, perhaps as part of post-doctoral studies.

Similarly, the impact of macroeconomic factors and business cycles on risk management perceptions across different regions could be investigated. Considering that each country has a particular dynamism related to the macroeconomy with specific implications for various risk dimensions in that particular framework, such economic realities should be considered as part of risk management-related studies.

The third limitation has to do with the approach to the research process. In addition to the qualitative research methodology as utilised by this study, a quantitative methodology based on secondary data with econometric analysis to measure the ‘actual’ findings in literature against the ‘perceptions’ as studied in this research could also have been considered.

It should be noted that time and cost limitations were restricting factors for the research to address the first three limitations.

Finally, the fourth limitation has to do with literature review. The literature on risk management in Islamic banking was limited and thus the references were seriously affected.

SUGGESTIONS FOR FUTURE RESEARCH

There is still wide scope for improvement and for further research. Having mentioned the limitations that were identified and discovered throughout the research process, the researcher would like to make suggestions and recommendations which may be taken from this study for future research either to enhance the study or as a basis for new studies in the field.

Future studies may expand the scope of the sample, enlarging the coverage to include respondents from more countries and with more diversified backgrounds.

This study accessed the perception of Islamic banking professionals about risks facing IFIs. It is also possible to seek the views and perceptions of Islamic banking customers themselves. Expanding the sample in this way would allow the researcher to use probability sampling techniques. The outcome of random sampling may enable the researcher to obtain data that is more representative and would assist the researcher to make more conclusive analyses by using robust statistical tools such as parametric statistical tools.

Although the research sample for this study comprised a wide range of respondents with different backgrounds within the industry, no regulators were included. It would be useful to obtain regulators' views on the issues discussed in this book. Including regulators in the research sample would give additional insights in relation to their role in improving risk management standards in Islamic banking.

Furthermore, the cultural aspects of risk management and the impact of regional cultural differences on the risk perception of respondents should have been examined as each region has its unique culture which shapes its risk management.

This study focused on risk management within Islamic banking. Further research may attempt to extend the study to analyse risk management among takaful companies, Islamic brokers and Islamic funds, and to expand the research into risk management across the whole wider Islamic finance industry.

Finally, as mentioned in the previous section, secondary data-based econometric analysis should also be considered in future research to observe and model the articulation and practice of risk and risk management in IBF. As mentioned, this could help to measure the ‘actual’ against the ‘perceptions’ as studied in the research.