Islamic Financing vs Conventional
Risk Management – Differences Between Islamic and Conventional Banking
In evolving the Islamic financial system, important considerations include the development of a system that is able to meet the changing requirements of the consumer and business community, that is efficient and competitive, that is safe and sound and that is robust and resilient and able to withstand a more challenging and uncertain world environment. These considerations are vital to ensure the sustainability of the system not only as a form of financial intermediation in the domestic economy but also as an integral component of the international financial system. 1
However the features of Islamic banks and their intermediation models that they follow eg the Profit and Loss Sharing (PLS) method and the Non Profit and Loss Sharing(NPLS) method involves special risks that have to be recognized to assist in making risk management in Islamic banking more effective.
The Profit and Loss Sharing method:
This method of financing is very much different from the conventional as it uses the concept of profit and sharing for example when a corporate wants us to finance their project the bank uses the concept of Mudaraba where the bank act as investor and the corporate as the entrepreneur . As Islamic banking prohibits against repayment of a fixed or floating interest rate, this concept provides a risk to the bank as the entire financing will be provided by the bank and the customer (entrepreneur) merely provides his experience and labour, however any profit gained by this project will be shared between the bank (investor) and the customer (entrepreneur). If however should the the project have been mismanaged thus resulting in getting a lesser profit , the profit will be share among both parties as agreed in accordance to the agreed profit sharing ratio. However if in the even there is a failure with the project thus arising in a ed
Non Profit Sharing Method:
This concept of financing is
In evolving the Islamic financial system, important considerations include the development of a system that is able to meet the changing requirements of the consumer and business community, that is efficient and competitive, that is safe and sound and that is robust and resilient and able to withstand a more challenging and uncertain world environment. These considerations are vital to ensure the sustainability of the system not only as a form of financial intermediation in the domestic economy but also as an integral component of the international financial system. 1
However the features of Islamic banks and their intermediation models that they follow eg the Profit and Loss Sharing (PLS) method and the Non Profit and Loss Sharing(NPLS) method involves special risks that have to be recognized to assist in making risk management in Islamic banking more effective.
The Profit and Loss Sharing method:
This method of financing is very much different from the conventional as it uses the concept of profit and sharing for example when a corporate wants us to finance their project the bank uses the concept of Mudaraba where the bank act as investor and the corporate as the entrepreneur . As Islamic banking prohibits against repayment of a fixed or floating interest rate, this concept provides a risk to the bank as the entire financing will be provided by the bank and the customer (entrepreneur) merely provides his experience and labour, however any profit gained by this project will be shared between the bank (investor) and the customer (entrepreneur). If however should the the project have been mismanaged thus resulting in getting a lesser profit , the profit will be share among both parties as agreed in accordance to the agreed profit sharing ratio. However if in the even there is a failure with the project thus arising in a ed
Non Profit Sharing Method:
This concept of financing is