294 AN INTRODUCTION TO ISLAMIC FINANCE
in compliance with the Shari’ah and take any necessary actions to avoid any
non - compliance.
Some Shari’ah scholars have suggested that if a bank fails to act in
accordance with the Shari’ah rules, the transaction should be considered
null and void and any income derived from it should not be included in the
profi ts to be distributed to the investors/depositors.
Reputation Risk
Reputation risk or “headline risk” is the risk that the trust of the clients is
damaged by irresponsible actions or behavior on the part of the bank. The
implications of this are wide - ranging in that the irresponsible behavior of a
single institution can taint the reputation of other Islamic banks. Negative
publicity can have a signifi cant impact on an institution’s market share,
profi tability and liquidity. The Islamic fi nancial services industry is a rela-
tively young industry and a single failed institution can give a bad name to
all others that may not be engaged in any such irresponsible behavior. Close
collaboration among fi nancial institutions, the standardization of contracts
and practices, self - examination, and the establishment of industry associa-
tions can help to mitigate reputation risk, to which all Islamic banks in a
given market are exposed.
An IFI enters into a contract with its stakeholders that it will conduct
its business according to the spirit of Shari’ah and is required to fulfi ll this
obligation to the best of its abilities. In addition, the institution has made an
implicit contract to ensure that no violation of Shari’ah principles occurs.
Anytime it fails to meet these obligations or is guilty of breach of contract,
it runs the risk that stakeholders will withdraw their business.
The IFI is subject to higher standards of preserving the property rights
of its stakeholders and to ensure that it does not withhold anyone’s rights,
willingly or unwillingly. To breach this sacred trust would be to risk its
reputation.
Risks Associated with Sukuk
As the sukuk market expands, it is important that the risks associated with
it are fully understood. On the surface, a sukuk appears to be like a debt -
based fi xed - income security. This being the case, the common practice is to
apply to it the same risk management framework. However, a sukuk has
distinctive features that can give rise to non - conventional risks, as outlined
below.
Although similar in structure, sukuk are different from conventional asset -
backed securities. By design, a sukuk is supposed to be a true asset - based
securitization where the risk/return is passed on to the owners. However, the
practice is different and it is often structured to minimize direct exposure to
the underlying assets. The investors need to understand the structure and the
exposures of each structure.