Islamic Banking – Products, Contracts & Risk (SEU334 Part II)

35 question-and-answer flashcards covering Islamic banking products, contracts, risk types, and risk-management tools for SEU334 Part II.

What are the two broad product categories offered by Islamic banks?

Financing products and Deposit products.

Which two contracts are commonly used for Islamic bank deposit accounts?

Wadiah (safekeeping) and Mudarabah (profit-sharing investment).

In which deposit contract does the bank guarantee the return of the customer’s principal but not share profit?

Wadiah.

Which deposit contract allows a customer to share profit with the bank according to a pre-agreed ratio?

Mudarabah (investment deposit).

Name two asset-based financing contracts in Islamic banking.

Murabahah and Tawarruq.

Name two equity-based financing contracts in Islamic banking.

Mudarabah and Musyarakah.

Which type of financing is considered the “ideal and universal” mode in Islamic banking?

Equity-based financing.

List the five essential elements of an asset/debt-based contract such as Murabahah.

Buyer, Seller, Object of the contract (merchandise), Price, Offer & Acceptance.

How does a bank earn profit in a Murabahah transaction?

By selling an asset to the customer at cost plus a disclosed profit margin on a deferred-payment basis.

In Tawarruq, why does the customer (or bank acting as agent) sell the commodity to Broker B?

To convert the commodity into cash while owing the deferred sale price to the bank.

Which Islamic contract is a manufacturing or construction agreement for a made-to-order asset?

Istisna’.

In a Mudarabah investment deposit, who bears any losses that occur?

The capital provider (customer) bears 100 % of the losses.

In a Mudarabah financing arrangement where the bank provides capital, who bears losses?

The bank (capital provider) bears 100 % of the losses.

How are losses shared in a Musyarakah partnership?

According to the ratio of capital contribution agreed by the partners.

What feature distinguishes Musyarakah Mutanaqisah from standard Musyarakah?

The bank’s ownership share diminishes gradually as the customer buys it out while simultaneously leasing the bank’s portion.

Which contract involves the bank purchasing an asset and then leasing it to the customer?

Ijarah.

State the three components of market risk faced by Islamic banks.

Foreign exchange risk, Profit (interest) rate risk, and Equity price risk.

Define credit risk in the context of Islamic banking.

The possibility that a customer or third party fails to meet obligations in accordance with agreed terms.

What is operational risk?

Risk of losses from inadequate or failed internal processes, people, systems, or external events (including legal and compliance risks).

What does liquidity risk refer to for an Islamic bank?

The risk arising from inability to meet withdrawal demands or shortage of funding.

What is equity investment risk (EIR)?

Risk arising from entering partnerships or holding equity positions, exposed to the performance of the manager/partner and business operations.

What is displaced commercial risk?

Risk that a bank sacrifices part of its own returns to pay competitive rates to investment account holders to prevent them from moving to conventional banks.

Define compliance (Shariah) risk.

Risk of loss due to violations of laws, regulations, or failure to comply with Shariah principles set by the Shariah Supervisory Board.

Which three risks are unique to Islamic banking (not shared with conventional banks)?

Equity investment risk, Displaced commercial risk, and Compliance (Shariah) risk.

What is the first step in the Islamic bank risk-management process?

Identifying key risk factors.

List the four primary risk-management tools discussed for Islamic banking.

Economic capital, Expected loss, Value-at-Risk (VaR), and Stress testing.

How is economic capital defined?

Capital held as protection against unexpected future losses at a selected confidence level.

What does expected loss (EL) represent?

The anticipated average loss over a defined period, treated as a normal cost of doing business and priced into products.

What does Value-at-Risk (VaR) measure?

The maximum expected loss of an asset or portfolio over a set time horizon at a given confidence level.

Name the two main categories of stress testing.

Sensitivity testing and Scenario testing.

In the Murabahah example, if cost is RM10,000 and profit is RM10,000, what is the selling price?

RM20,000.

In the Tawarruq example, what is the monthly installment to repay RM50,000 over 60 months?

Approximately RM833.33 per month.

During Musyarakah Mutanaqisah, what arrangement lets the customer use the bank’s 90 % share of a house?

A lease (Ijarah) agreement on the bank’s share.

Why can relying mainly on current accounts heighten liquidity risk for Islamic banks?

Because it may create a shortage of stable long-term funds to meet withdrawal demands.

When are expected losses typically absorbed by an Islamic bank?

They are absorbed through operating income as part of normal business costs.