Stress Testing and Reverse Stress Testing: An Approach for a Resilient Islamic Financial Industry

  • Samir Alamad


Stress testing is an important tool for risk management in the operation of Islamic financial and capital markets. Islamic financial market’s (IFM) instruments use different stress testing and liquidity risk approaches due to considerations relating to their regional, regulatory, legal, product and operational requirements that may dictate a certain approach and stress scenarios to manage the associated risks and test their ability to absorb market shocks. This chapter provides in-depth insights into the best market practices for stress testing framework for the survival of Islamic financial markets and institutions in the face of possible market shocks, within a sophisticated financial market in Europe. This subject is important for two reasons: firstly, the survival of an Islamic financial market and its institutions is hugely dependent on its risk factors and stress testing management approaches. Secondly, the ability of managing such market shocks without compromising Shari’ah requirements is a very important component for Islamic financial institutions (IFIs). The study collects its data by using the method of a case study to obtain in-depth knowledge from the Bank of England and IFIs in the UK. The findings of the study identify key stress testing steps and assessment in addition to risks that are crucial for the survival of the IFM and its institutions. It also suggests a stress testing approach that could reduce the impact of financial shocks to the IFM and ensure its resilience.


Stress testing Liquidity risk Risk management Financial markets Prudential regulations 


  1. Ahrens, T., & Chapman, C. S. (2006). Doing qualitative field research in management accounting: Positioning data to contribute to theory. Accounting, Organizations and Society., 31(8), 819–841.CrossRefGoogle Scholar
  2. Ali, S. S. (2012). State of liquidity management in Islamic financial institutions. Islamic Economic Studies, 21(1), 63–98.CrossRefGoogle Scholar
  3. Bank of England. (2014). Stress testing in the UK banking system: 2014 results. London: Bank of England.Google Scholar
  4. Barfield, R., & Venkat, S. (2008). Liquidity risk management. In The Journal-Global Perspectives on Challenges and Opportunities. London: PricewaterhouseCoopers.Google Scholar
  5. BCBS (2006). The management of liquidity risk in financial groups. Basle: Basel Committee on Banking Supervision.Google Scholar
  6. BCBS (2009). Principles for sound stress testing practices and supervision. Basle: Basel Committee on Banking Supervision.Google Scholar
  7. BIS. (2000). Stress testing by large financing institutions: Current practice and aggregation issues. In April 2000. Basle: Bank for International Settlements.Google Scholar
  8. BIS. (2008). Basel committee on banking supervision- principles for sound liquidity risk management and supervision, September 2008. Basle: Bank for International Settlements.Google Scholar
  9. BIS. (2009). Basel III: international framework for liquidity risk measurement, standards and monitoring, December 2009. Basle: Bank for International Settlements.Google Scholar
  10. BIS. (2010a). Basel committee on banking supervision-iInternational framework for liquidity risk measurement, standards and monitoring, December 2010. Basle: Bank for International Settlements.Google Scholar
  11. BIS. (2010b). Basel III: A global regulatory framework for more resilient banks and banking systems, December 2010. Basle: Bank for International Settlements.Google Scholar
  12. Board of Governors of the Federal Reserve System. (2012). Guidance on stress testing for banking organisations with total consolidated assets of more than $10 billion. Washington, D.C: Board of Governors of the Federal Reserve System.Google Scholar
  13. Borio, C., Drehmann, M., & Tsatsaronis, K. (2012). Stress-testing macro stress testing: Does it live up to expectations? In BIS working papers No. 369. Basle: Bank for International.Google Scholar
  14. CEBS. (2010). CEBS guidelines on stress testing. London: European banking authority.Google Scholar
  15. Czarniawska, B. (1999). Writing management: Organization theory as a literary genre. Oxford: Oxford University Press.CrossRefGoogle Scholar
  16. Dyer, W. G., & Wilkins, A. L. (1991). Better stories, not better constructs to generate better theory: A rejoinder to Eisenhardt. Academy of Management Review., 16(3), 613–619.CrossRefGoogle Scholar
  17. ECB. (2008). EU banks’ liquidity stress testing and contingency funding plans. Frankfurt: European Central Bank.Google Scholar
  18. FCA. (2014). Stress Testing and Contingency Funding. London: Financial conduct authority.Google Scholar
  19. Fell, J. (2006). Overview of Stress Testing Methodologies: From Micro to Macro. presentation to the Korea Financial Supervisory Commission/Financial Supervisory Service-International Monetary Fund Seminar on Macroprudential Supervision Conference on Challenges for Financial Supervisors, Seoul, November 7, 2006.Google Scholar
  20. Flyvbjerg, B. (2001). Making social science matter. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
  21. Garfinkel, H. (1967). Studies in ethnomethodology. Cambridge: Polity Press.Google Scholar
  22. GARP. (2011). A new regulation for liquidity risk. In Global Association of Risk Professionals. New Jersey.Google Scholar
  23. Grundke, P. (2011). Reverse stress tests with bottom-up approaches. The Journal of Risk Model Validation, 5(1), 71–90.CrossRefGoogle Scholar
  24. Jönsson, S., & Macintosh, N. (1997). CATS, RATS, and EARS: Making the case for ethnographic accounting research. Accounting Organizations and Society, 22(3–4), 367–386.CrossRefGoogle Scholar
  25. Matten. (2009). Stress testing liquidity and the contingency funding plan. PRMIA Members’ Meeting, February 24, 2009.Google Scholar
  26. OSFI. (2009). Stress testing: Sound business and financial practices. Ottawa: Office of the Superintendent of financial institutions.Google Scholar
  27. Peria, M. S. M., Majnoni, G., Jones, M. T., & Blaschke, W. (2001). Stress testing of financial systems: An overview of issues, methodologies and FSAB experiences. In IMF working paper No. 01/88. Washington DC: International Monetary Fund.Google Scholar
  28. Schatzki, T. R. (2005). The sites of organizations. Organization Studies, 26(3), 465–484.CrossRefGoogle Scholar
  29. Schmieder, C., Claus, P., Maher, H. (2011). Next Generation Balance. Sheet Stress Testing, IMF working paper. April, WP/11/83.Google Scholar
  30. Schmieder, C., Hesse, H., Neudorfer, B., Puhr, C., & Schmitz, S. W. (2012). Next generation system-wide liquidity stress testing. In IMF working paper WP/12/3. Washington DC: International Monetary Fund.Google Scholar
  31. TATA. (2013). A stress testing framework for liquidity risk. Mumbai: TATA Consultancy Services Limited.Google Scholar
  32. van den End, J. W. (2010). Liquidity stress-tester- do Basel III and unconventional monetary policy work? In Working paper No. 269. Amsterdam: De Nederlandsche Bank.Google Scholar

Copyright information

© Islamic Research and Training Institute 2019

Authors and Affiliations

  • Samir Alamad
    • 1
  1. 1.Aston UniversityBirminghamUK

Personalised recommendations