Risk Management 287
depositors. It has been suggested that making deductions from the profi ts
belonging to investment account holders should apply only to long - term
depositors, who are more likely to be exposed, and not to depositors who
are not exposed to such risk.
Withdrawal risk: Withdrawal risk arises mainly from the competitive
pressures an IFI faces from its Islamic or conventional counterparts. An
Islamic bank could be exposed to the risk of withdrawals by its deposi-
tors as a result of offering a lower rate of return than its competitors. If an
Islamic bank is run ineffi ciently and keeps producing lower returns, this will
lead to withdrawals, which could eventually erode the franchise value of
the bank.
Treasury Risks
Treasury risks include those arising from cash management, equity man-
agement, short - term liquidity management, and assets - and - liabilities
management (ALM). Generally, responsibility for the risk management
function of a fi nancial institution falls to the treasury and therefore any
inability to manage risks properly can be a risk itself. Typical treasury
risks that are critical for an IFI are liquidity, ALM, and hedging risks, as
discussed below.
Liquidity Risk Liquidity is necessary for banks to compensate for any fl uctu-
ations (expected and unexpected) in the balance sheet and to provide funds
for growth. It represents a bank’s ability to accommodate the redemption
of deposits and other liabilities and to cover the demand for funding in
the loan and investment portfolio. A bank is said to have adequate liquid-
ity potential when it can obtain needed funds (by increasing liabilities, or
securitizing/selling assets) promptly and at a reasonable cost. The price of
liquidity is a function of market conditions and the market’s perception
of the inherent riskiness of the borrowing institution.
Liquidity risk also results when the bank’s ability to match the maturity
of assets and liabilities is impaired. Such risk results from the mismatch
between maturities on the two sides of the balance sheet, creating either
a surplus of cash that must be invested or a shortage of cash that must be
funded. Lack of liquidity adversely affects the bank’s ability to manage
portfolios in a diversifi ed fashion and to enter or exit the market when
needed.
Liquidity risk as it applies to Islamic banks can be of two types: lack of
liquidity in the market, and lack of access to funding. In the fi rst type, illiq-
uid assets make it diffi cult for the fi nancial institution to meet its liabilities
and fi nancial obligations. In the second, the institution is unable to raise
funds at a reasonable cost, when needed.
Since an IFI will be acting as an asset manager and will not have access
to funds through a debt security to meet its liquidity needs, it will be exposed