Risk Management 283
similar to the market risk of a forward contract if it is not hedged properly.
In order to hedge its position, the bank may enter into a parallel (offsetting)
bay’ al - salam contract, leaving itself exposed to price risk if there is default on
the fi rst contract and the bank is obligated to deliver on the second contract.
Leased Asset - value Risk In the case of an operating ijarah, the bank is exposed
to market risk over the life of the contract arising from a reduction in the
residual value of the leased asset at the expiry of the lease term or, in the case
of early termination, due to default.
FX Risk The movement of foreign exchange rates is another transaction risk
arising from the deferred trading nature of some contracts offered by Islamic
banks, as the value of the currency in which receivables are due may depreci-
ate or the currency in which payables are due may appreciate.
Securities Price Risk With an increasing market for Islamic bonds (sukuk),
Islamic banks invest a portion of their assets in marketable securities.
However, the prices of such securities are exposed to current yields. Similar
to a fi xed-income security, the prices go down as yields go up and vice versa.
Islamic banks holding such securities will be exposed to volatility in yields,
unless they hold the security till maturity. Furthermore, the secondary
market for such securities may not be very liquid, exposing the banks to
distorted prices in an illiquid market.
IFSB PRINCIPLES OF MARKET RISK
Principle 4.1: [Islamic Financial Institutions] shall have in place an
appropriate framework for market risk management (including report-
ing) in respect of all assets held, including those that do not have a
ready market and/or are exposed to high price volatility.Equity Investment Risk
IFIs are exposed to equity investment risk in profi t/loss - sharing investments
on the assets side. These include partnership - based mudarabah and musha-
rakah investments. Typical examples of equity investments are holdings of
shares in the stock market, private-equity investments, equity participation
in specifi c projects or syndication investment.
This risk is unique to IFIs because conventional commercial banks do not
invest on the basis of equity - based assets. Equity investments can lead to vol-
atility in the fi nancial institution’s earnings arising from liquidity, credit, and
market risks associated with equity holdings. Although there is credit risk in
equity - based assets as discussed earlier, there is also considerable fi nancial
risk of losing capital invested as a result of business losses.