Risk Management 293
Fiduciary risk can lead to dire consequences. First, it can damage a bank’s
reputation and create panic among depositors, who may decide to withdraw
their funds. Secondly, it may result in legal action that can lead to a fi nancial
loss in the form of penalties or compensation payments. Thirdly, it can have a
negative impact on the market price of shareholders’ equity and on the bank’s
costs and access to liquidity. Where a bank is unable to meet the demands of
its current and investment account holders, it may lead to insolvency.
Transparency Risk
Transparency is defi ned as “the public disclosure of reliable and timely infor-
mation that enables users of that information to make an accurate assess-
ment of a bank’s fi nancial condition and performance, business activities, risk
profi le and risk - management practices.” Accordingly, lack of transparency
creates the risk of incurring losses from bad decisions based on incomplete
or inaccurate information. Islamic banks are exposed to transparency risk by
the practice of non - standard accounting and fi nancial reporting of Islamic
fi nancial instruments, which are different from conventional instruments and
therefore require different conventions of reporting to truly refl ect the fi nan-
cial picture. Transparency also demands that all banks in the system use a
uniform set of standards, which is not the current practice.
Shari’ah Risk
Shari’ah risk is related to the structure and functioning of the Shari’ah
boards at the institutional and systemic level. This risk is of two types: the
fi rst comes from non - standard practices in respect of different contracts in
different jurisdictions; the second is the result of failure to comply with
Shari’ah rules. For instance, while some Shari’ah scholars consider the terms
of a murabahah or istisna’ contract to be binding on the buyer, others argue
that the buyer has the option to decline even after placing an order and
paying the commitment fee. While each practice is acceptable to different
schools of thought, the bank’s risk is higher in non - binding cases and it may
lead to potential litigation problems in unsettled transactions.
Banks are exposed to the risk of non - compliance with the Shari’ah rules
and principles determined by the Shari’ah board or the relevant body in their
particular jurisdiction. The nature of the relationship between the bank and
the investors/depositors is not only that of an agent and principal, but it is
also based on an implicit trust between the two that the agent will respect the
desires of the principal to fully comply with the Shari’ah. This relationship
distinguishes Islamic banking from conventional banking and is the sole justi-
fi cation for the existence of the Islamic banks. If the bank is unable to maintain
this trust and its actions lead to non - compliance with the Shari’ah, it runs the
risk of breaking the confi dence of its investors/depositors. Breaching this
trust can have dire consequences, including the withdrawal and insolvency
risk. Therefore, the bank should give high priority to ensuring transparency