OPERATIONAL RISK IN ISLAMIC BANKS

OPERATIONAL RISK IN ISLAMIC BANKS

Abstract

This paper portrays the operational risks experienced by Islamic banks, and the apparatuses created dependent on the working standards of Islamic banks. In light of the measure of activity, here is the Islamic Bank’s Operational Risk Theory, which examines the show banking framework and the Islamic bank activity framework. Operational risk in the bank is combined through a four-step identification of the risk management system, which attempts to address the solvent factors variables of the affected risk. Through a systematically modified step-gate process, it identifies and analyzes operational risks, examines the operational risk of the project, and advises them to overcome threats through the investigation of selected projects. The paper illuminates the interaction between decision-making factors for greater operational and technical implications.

An Analysis of Operational Risks in Islamic Banks

Introduction

Operational risk can be characterized as an inside procedure of the organization and insufficient systems to shield the organization from startling risks. In the “Operational Risk Management” paper distributed in 1998 by the Basel Committee on Banking Supervision, operational risk was at first thought to be a self-administrative control issue (Khan and Ahmed, 2001). Operational risk is a developing duty regarding any keep money with expanded administration, multifaceted business nature, request procedures and frameworks, and rising advances, while operational risk keeps on expanding in scale and significance for some banks (Zenab & Mensi, 2014). It is additionally indicated that there are numerous sources, for example, human blunder in operational risk, extortion during activity, chance from the framework, exchange questions. Operational risk is harder to characterize or evaluate than credit or market issues in the financial area.

This venture underscores the operational risk the board approach in the financial area. Keeping up the operational risk of an Islamic bank is constantly a significant test that influences money related exchanges, yet is inactive. This is on the grounds that benefit, and misfortune sharing (PLS) is one of the primary highlights in the Islamic financial framework, securing value and equity in the economy. Along these lines, recognizing the riskiest operational risk in Islamic financial recognition is the sharia chance free operational risk.

Our project managers are ready to assist in the establishment of priorities, allocation of existing resources, and implementation of tasks and processes that reduce the likelihood of a goal collapse. KRI is a systemic method for identifying critical risks through the process and measuring risk through qualitative or quantitative tools.

Literature Review

Principle of Islamic Banking

The two principle terms in this paper are the Islamic Bank and Operational Risk. The above presentation shows that Islamic banking is a budgetary mediator framework that abstains from getting and paying enthusiasm on its exchanges. Then again, benefit and misfortune sharing (PLS) is one of the primary highlights in the Islamic financial framework, ensuring value and equity in the economy. This office is regularly alluded to as the PLS banking framework. Three of the five establishments of the Islamic financial framework are Ambrose, and two are mindful (Ranoui & Belkhoutout 2018). The standards of the Islamic financial framework are delineated by Figure 1 underneath.

From the point of view of the Islamic banking system, the primary operation is to protect equity and justice in the economy and share profits and losses among shareholders. Banking is a mandatory task to deal with risky activities due to operations. According to the Competence Center for Operational Risk, there are different risk experts at the group and local level (Goodhart, 2001). In fact, it has reinforced its critical role as a cross-border commodity”, including the possibility of a change from the expected or the path to a simple outcome (Vaughan (1999).

Islamic Banking Risks in Theory

Islamic banks are presented to two kinds of risk with the looking at by the ordinary banks and risks. In the project, we tried to explicit the activity of the bank which schematizes with Islamic banks activity risk in (Figure)

According to the above fig., Operation risk is a common risk for all banking sectors that specifically represent Islamic banks and their traditional counterparts. However, the Islamic banking concept considers the risk of Sharia as an operational risk (which is typical for Islamic banks).

 These risks incorporate risks of not sticking to Sharia and clinging to Sharia and disassembling tasks in the Bank’s Operational Risk Management Project (Rhanoui and Belkhoutout, 2018). Operational risks incorporate inward misrepresentation, outer extortion, harm to physical resources, business disturbance and framework disappointment, business practices and working environment security, and the sky is the limit from there. IFSB gives a supplement to operational risks for Islamic banks.

Methodology and Data

The purpose of this paper is to develop an operational risk tool that supports risk managers in the measurement, monitoring, reporting, and operational risk control at the local business unit level in Islamic banks. This is a test-practice Islamic banking operational risk; The qualitative approach is more appropriate. All data were collected from recent reports of Islamic banks. This qualitative approach makes it possible to capture the realities of operational risk without the intervention of solid data collection, interference, to ensure a direct evaluation of our project and the validity of the project’s results. Variables listed as operational risk sources have been observed in the literature review above (Chernobai, 2008). According to Eid and Kamal (2012), the risk management process consists of three steps.

• Risk Identification Step: Risk is identified through risk mapping.
• Evaluation Phase: Risk is measured by qualitative or quantitative instruments.
• Reducing Step: Risk mitigation strategies are implemented based on the objects of the project.
• Review step: Monitoring and reporting activities for the Operational Risk Project are provided in the middle or final tram review of risk management.

After identifying potential operational risk for each phase and accumulating that operational risk in our project, we develop a systematic methodology that examines the characteristics that challenge the operational risk measurement of the project and provides suggestions to overcome the risks through research of selected projects.

Operational risk and sources of identification: The effect of immediate risks can be about the interior procedures, the disappointment of individuals and frameworks, or activity emerging from outer occasions. During a money related emergency, each commonsense shortcoming, for example, framework or procedure disappointments, documentation mistakes, extortion and consistency issues are uncovered (Ghosh, 2012).

Key Risk Indicators (KRIs)

 Risk identification is the process of identifying all available risks that negatively or positively destabilize a project. This is relevant in the risk identification process requiring input from all project stakeholders outside the core project team using KRI. Key Risk Identification (KRI) is a parameter to determine the key function of the management’s functionality. It contains performance indicators (PIs) that have led to empirical data for the system, as indicated by the PI. KRI controls the entire management system and is a potential contributor to risk identification, below project members (Anderson et al., 2016).

• Members of the Risk Management Team
• Subject matter experts (IT, security, legal)
• End user
• Customers (internal and external)

Value at Risk refers to the losses banks that could suffer after certain positions lose their value. The risk is based on the possibility of the bank suffering a loss in a particular investment portfolio within the stipulated timeframe. The amount is determined by using proprietary models or historical data (Zeineb & Mensi, 2014). The banks use their potential exposure to losses to determine this indicator in the operational process. The indicator could help estimate the loss resulting from reputational harm and inadequate investment plans. The indicator shows the bank’s current liquidity. The ratio shows the banks’ ability to pay for its current liabilities. A bank is at risk if it has taken a high amount of liability than what the assets at its disposal can cover. On the other hand, the Target Not Met indicator reveals the ability of the bank to meet all its financial obligation.

The measures of the banks current level of liquidity define its quick ratio. A bank with a low level of metric has a large amount of liability compared to the current assets. The risk can show the risk of the bank’s ability not to meet its obligations.  Banks have different targets during their operations. The failure of the banks to meet their financial targets exposes its risks. The indicator shows the extent to which the bank is meeting its targets as it fights to beat the competition (Zeineb & Mensi, 2014). The failure of a bank to meet its targets increases its risk in reputation, finance, and operations.

It has the exhibition markers (PI’s), which drive the observational information of the framework according to the PI’s sign KRI’s controls the entire administration framework and potential supporters of recognizable risk proof incorporate task colleagues are as underneath; (Andersen et al., 2016). A risk management team is essential in banking.  The team is independent and separate from the bank operation. A risk manager is appointed to lead the team and helps in determining the level of project activities within the bank. The team is tasked with developing strategies. The team also controls and oversees the effectiveness of the projects. Additionally, subject matter professionals should be part of the bank team.  The experts perform a risk assessment and impact analysis to reduce the probability of disasters or outages of services in a bank.

Root cause analysis

Root Cause Analysis (RCA) is a method for identifying the root cause and used by KRIs as a class of problem-solving techniques or events. The main drivers of the complaints and their service to the Bank’s operations manager can forward the idea (Ishikawa, 1982). The Fishbone Diagram Technique System Flow Chart is circumstances, and logical results outline utilized by KRIs to feature changes that are not obviously expressed in the main drivers of issues (Macinde et al., 2017).

Managers use RCA in Islamic banks to introduce evidence-based methodologies to resolve complex problems. RCA is considered a shareable, scalable and powerful tool applicable in the banking industry. The tool helps managers to resolve problems not only effectively but also quickly. Teams of diverse expertise take advantage of RCA to stream their operation for increased productivity of the bank. Using these methods, it is easy for managers to create, refine, track as well as to measure the complexity of different projects at their disposal. The banks reduce their risk of operation and boost productivity by identifying the ingrained data and areas of weakness. Additionally, RCA empowers workers in various departments within the banks, thereby resolving the issue of blame-game. The banks reduce their reliability on outdated solutions once they embrace evidence-based ways of handling operations.  Through learned behaviour, the banks can realize progress in all departments. Banks managers can take advantage of the method to fix the real problem rather than wasting time on the obvious.

While there are different programs that can be used in RCA documentation, Reality Charting is the most effective. Using the methodology, it is easy to establish tangible and concrete things. For instance, if someone cannot log into the system of the bank and report the existence of a bug, the entire system has a bug. At this point, it is not easy to track; hence it makes RCA more complex. Unless a bank goes deeper to understand RCAs, it could consider some issues to lack solutions. Most of the banks investigate less than 50 per cent of their problems. The banks should be in a position to define and implement the preventive measures to various problems identified through RCA (Ishikawa, K. 1982). Banks’ failures in risk management make them vulnerable to assess their level of progress. Although the level of risk of banks differs, the management must ensure to attain its corporate objectives to remain in the field.

For instance; Customer administration is a long line process. Use of lining models, framework models and reenactments can fill in as a potential device for taking out lines experienced in banking administration the board.

For the purposes of the current negotiations, it is not possible to go into particular Islamic bank detail and collect information from employees, stakeholders and even review the fact sheet to understand the implications of the risk. Considerable reliance on case studies and available literature on various risk identification models. Further analysis and process categories will be placed on these results.

Figure: 04 Fish Bone diagram depicting the root causes of long queues in the banking industries (Makinde et al., 2017).

It is necessary to collect information about specific Islamic banks from the employees, stakeholders, and even review the fact sheets to understand the implication of the risk; it is notable for highlighting that the significant reliance on case studies and the available literature on different risk identification model is one straight-forward stance to inculcate. It is upon these findings that the subsequent analysis and process factions are placed.

Analysis and Policy:

We develop and implement the Stage-Gate process for the final stages of operations management, control and monitoring. Accept the final issue, identification, or decision for the project from the four stages applicable to the phase-gate process. Decision making and the development of new technology, technology management or a decision to run, edit, optimize and ideas for improving, for the production of new high-speed, thin and become more effective as a means to influence decisions and the ability to enhance the process of development to the doorstep. I would like to introduce this revised Stage-Gates process for our operational risk management project to reduce risk and make decisions without uncertainty in the banking operations sector. Outline the stages of the division for specific requirements and criteria for the different stages and gates shown below each division (Figure: 03)

As can be seen in figure 5, the first step that is needed in the process of managing risk in the Islamic banks is the ideation.  This is identified as the most critical step because it marks the commencement of problem resolution. At present, it is evident that Islamic banks, as supported by research evidence, are marred by risks as regards their operative stances. Once the issue concerning the many problems that characterize the Islamic banks has been identified, the proposed ideas then undergo what is identified and noted as the initial screening. This faction is popularly viewed as stage one of the problem resolution stance. Thereafter, there is the requirement to now validate the concept that was proposed at the initial stance. Depending on the observations that are witnessed in this particular stage, it is essential to point out that this fundamentally leads the respective policymakers in the option development. At this particular point, the policymakers can now come up with a decision on the give banks. The one crucial consideration to note in this case is that the process seeks to identify the most effective as well as cheapest resolution stance that can be used to minimize risks in the usual operations of the bank.

The implementation realization is another progressive move that is inculcated to launch market utilization.  At the close of the post-implementation review, the bank is evaluated in terms of how effective it can operate given the salient market factors, stakeholder perceptions, and what is centrally feasible for the industry. The main objective of each of the phases is reducing the risk of the different phases while at the same time, ensuring that the cost is minimal. The banks strive to spend the least amount of resources on the projects. The project cannot be terminated at an early stage before the process is complete.

In choosing the best method for any bank, it is necessary to consider the cause of the losses. For example, if the risk is driven by factors such as higher borrowing with limited benefits from lower interest rates, it may represent a step-by-step approach to covering those fundamental issues. The interest rate should be similar to the stance while lowering the lending rate so that the bank’s liquidity rates are maintained.

Ideas for decision-making and new technology development projects from the above stage-gates are often obtained from a partner or collected from a KRI collector. In the Ideation phase, there are three stages: Idea Collector, Idea Development and Idea Evaluation. These are the revised Phase-Gate Process 1, which can sustain Gate, from project objectives, design and innovation work, to the product, full organizational standardization (Pfeiffer et al., 2010) and becoming an object in the area of ​​operation. Standardized innovation processes through the stage-gate process are more effective, less risky and comprehensively feasible for new product/project development (Cooper, 2009).

Overall, in reference to the structure and functional elements of the above frameworks, it is notable that although they are different in form and perspective, they still endeavour to attain immensely factual perspectives that can be used to understand the rate of problems in the Islamic banks as far as the operational risks are placed.

Results and discussion

There is no particular general or plainly obvious classification in the financial division, yet it is named by different techniques with the end goal of control and command over the tricky (Power (2005)). We have a solitary, worldwide system for overseeing operational risk over the whole task. The turn of events and execution of this structure bolsters the expansive operational risk of our vision model, which replaces the spread strings for all associations and ventures (Khan and Ahmed, 2001). The principle completes the following functions:

• Characterize least measures for the operational risk the executives’ system and operational risk the executive’s forms for the Risk venture.
• Advise the senior administration and control boards of trustees of the Risk operational risk profile.
• Arranging and leading free risk checks and difficulties to the Risk venture.

Recommendations

In general, this theory-based project analysis serves as an enhanced method of risk management for Islamic banking operations. The potential risk in Islamic banking will have to be dealt with as per the existing policies and processes of traditional parts, where the project will provide new technology for traditional parts. A revised model of the Stage-Gate Process theory strongly suggests how to manage and control operational risk while maximizing profitability (Khan & Ahmed, 2001).

Conclusion

The above discussion suggests that Islamic banks are faced with a myriad of challenges that are linked to operations. A review of the principles of operation reveals that the Islamic banks are not able to function adequately due to the existing loopholes in the functionality stances that characterize them. Still, an analysis of the conventional models that guide and direct banks across the globe. Islamic banks still have a long way to go as far as financial stability is placed. This is notwithstanding the fact that Islamic banks have a strong adherence to the rules and operative frameworks that are dictated by the Sharia law. Some of the models that have been reviewed in this case include the four-stage model of risk identification in the financial institutions. Among the aspects that have been suggested to improve the operative model of the Islamic banks is the utilization of the two-phase model, as opposed to the four-phased model of risk identification.

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Appendix:

Table 1. Operational risk factors in Islamic banks excluding non-compliance risk of Sharia.