Abstract
Risk recognition is a critical issue and is highly dependent on the competence of the risk manager. Because of that, risk management is a continuous process of risk reduction in corporate business dealings, and is associated with how companies select the type and levels of risks in order to foresee them in the best way.
In Islamic banking, credit and other risk management present a serious challenge due to their emphasized importance for clients and society, as well as business dealing commitments in accordance with the principles of shariah. Since numerous instruments for risk protection applied by conventional banks are not acceptable to Islamic banks, additional efforts must be made by the latter to find a suitable risk management model. On the other hand, risks faced by Islamic banks differ from those of conventional banks, or they are specific to a particular Islamic financial transaction and financing model. A separate issue appears in the interlacing of dissimilar risks, as is the usual case with credit and market risk.
The early warning sign (EWS) system can be used on the entire portfolio, as well as on the level of each and every client, and it is associated with the financial performance of the business activity of the debtor, default events and non-financial indicators that may influence credit capacity in the future as well.
EWS responds to unfavourable movements in the market, particularly the aggravation associated with the creditworthiness of firms from the real sector and also the deterioration of their credit portfolios. This is the reality that Islamic banks face daily. EWS is a concrete and very strong instrument to preserve the quality of financial institutions’ assets.
The authors aim to test EWS’s applicability as a system for the quality management of credit portfolios in the business activities of Islamic banks and to offer concrete solutions that will help to introduce this modern and innovative system for banking risk management into the business dealings and practice of Islamic banks.
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Notes
- 1.
Bessis, J., (2003) Risk Management in Banking. John Wiley & Sons. p. 41, 42.
- 2.
See: Hadžić, F., & Softić, A., (2011). Standardization and design of risk management models, p. 5.
- 3.
See: Hadžić, F., & Softić, A., (2011). Standardization and design of risk management models, p. 1.
- 4.
Khan, T., & Ahmed, H., (2001) Risk management – An Analysis of issues in Islamic Financial Industry. Jeddah-Saudi Arabia: Islamic Development Bank: IRTI.
- 5.
Ibid, p. 103.
- 6.
Elgari-Ali M., (2003) Credit Risk in Islamic Banking and Finance, Islamic Economic Studies, Vol. 10. No. 2.
- 7.
Khan, T., (2005) Credit Risk management: A Framework for Islamic Banking, in Khan, T. & Muljawan, D., Islamic Financial Architecture: Risk Management and Financial Stability. Islamic Development Bank: IRTI. p. 400.
- 8.
Ibid. p. 405.
- 9.
Rosly, S. A., & Zaini, M. A. M., (2008) Risk-return analysis of Islamic banks’ investment deposits and shareholders’ fund, Managerial Finance, Vol. 34 No. 10. p. 698.
- 10.
Greuning, van H., & Iqbal, Z., (2008) Risk Analysis for Islamic Bank. IBRD, The World Bank, Washington, DC. p. 134.
- 11.
See ibid. p. 286.
- 12.
Hadžić, F., & Softić, A., (2009) Importance and role of credit portfolio in risk reduction function in the financial crisis conditions. Neum: 12th International Symposium, Journal, FBiH Association of Accountants and Auditors. p. 369, 370.
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© 2017 Islamic Research and Training Institute, Velid Efendić and Fikret Hadžić
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Hadžić, F., Softić, A. (2017). The Possibility of the Application of an Early Warning Sign System into the Quality Management System of a Credit Portfolio of Islamic Banks. In: Efendić, V., Hadžić, F., Izhar, H. (eds) Critical Issues and Challenges in Islamic Economics and Finance Development. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-45029-2_3
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