Islamic Finance: The New Regulatory Challenge, 2nd Edition

Chapter 7

Operational Risk Exposures of Islamic Banks

Simon Archer and Abdullah Haron

1. INTRODUCTION

Following the downturn of the financial markets in 2008, the Basel Committee on Banking Supervision (BCBS) has been striving to refine the rules for global financial services. A significant number of financial institutions, especially those classified as SIFI (systematically important financial institutions) had crossed the boundaries of risk taking. In the case of a few of them, their eventual failure posed systemic risks to the world economy, necessitating intervention by governments. As a result, international standard-setting organisations have been working to put in place a new set of regulations to govern financial markets more effectively. One of the most notable efforts made by the BCBS is the introduction of a set of guidelines known collectively as Basel III. At the same time, the Islamic Financial Services Board (IFSB) has formed several working groups with the aim of complementing this work of the BCBS, with regard, for instance, to liquidity risk management, stress testing, and revised requirements for capital adequacy and the supervisory review process.

While Basel III focuses on regulating solvency and liquidity to ensure sufficient capital to return funds to depositors and to be able to survive a protracted liquidity stress situation, the regulations come with some expected changes with respect to the way the institutions operate, a number of which this chapter ...