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RISK MANAGEMENT�FOR ISLAMIC�FINANCIAL INSTITUTIONS

WEEK 1

Understanding Risk Management

Risk concepts • Framework • Process • Identification

Ronald Rulindo, PhD • Nur Dhani, PhD

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WEEK 1

Course Objectives

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UNDERSTAND

Explain risk and the risk management process.

IDENTIFY

Recognize key risks in Islamic banks and how they differ from conventional banks.

ASSESS

Assess, prevent and mitigate risk exposures.

DEVELOP

Build Key Risk Indicators and Risk Control System Assessment.

SOLVE

Present solutions for risk management issues in Islamic banks.

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WEEK 1

Week 1 Roadmap

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Understanding Risks

→

Risk Framework

→

Importance of Risk Management

→

Risk Management Process

→

Risk Identification

Today is about building the conceptual foundation before moving to Islamic banking cases.

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Understanding Risk

Before managing risk, we need to define what risk actually means.

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SECTION 1

What Is Risk?

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Losses?

Uncertainty?

Speculation?

Danger?

Risk is often associated with negative outcomes — but the concept is broader.

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SECTION 1

Is It Risky? Perception Matters

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The same activity may be perceived differently depending on information, experience and tolerance.

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SECTION 1

Uncertainty: The Starting Point

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Uncertainty exists when we do not know whether an event will occur, whether a decision is right, or whether a statement is correct.

Will the event happen?

Will the decision produce the expected result?

Will the information turn out to be correct?

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SECTION 1

So, What Is Risk?

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Simple definition

The possibility that something unexpected happens.

ISO 31000

Risk is the effect of uncertainty on objectives.

Key point: without objectives, risk cannot be assessed properly.

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SECTION 1

Two Types of Risk

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DOWNSIDE RISK

The unexpected event is worse than expected. Example: loss, delay, default or reputational damage.

UPSIDE RISK

The unexpected event is better than expected. Example: demand is higher than projected or productivity improves.

Risk management is not only about fear. It is about managing uncertainty against objectives.

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SECTION 1

Risk vs Uncertainty: Perception & Communication

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When information is unclear, uncertainty increases.

Different stakeholders may perceive the same exposure differently.

Communication reduces misunderstanding but cannot eliminate all uncertainty.

Risk managers must translate uncertainty into actionable analysis.

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SECTION 1

Understanding Risk: Cause → Event → Impact

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CAUSE

Condition or factor that can trigger risk.

→

RISK EVENT

The unexpected event that may occur.

→

IMPACT

Effect on objectives if the event occurs.

This logic helps separate facts, possible events and consequences.

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SECTION 1

Risk Analysis Example

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CAUSE / FACT

RISK

RISK EVENT

IMPACT ON OBJECTIVES

Using non-original spare parts

Operational failure

Machine is broken

Delay in production target

Hiring experts as subcontractor

Increased capacity

Quality improves / overproduction

Target achieved sooner

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Risk Framework

A practical language for connecting sources, factors, exposures, events and impact.

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SECTION 2

Risk Framework: The Core Logic

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SOURCE OF RISK

Where risk originates

→

RISK FACTOR

Condition that increases possibility

→

EXPOSURE

Object or objective at risk

→

PERIL / EVENT

Unexpected occurrence

→

IMPACT

Effect on objectives

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SECTION 2

Example: Fire Risk Framework

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SOURCE

Api / fire source

FACTOR

Kerosene stored near stove

EXPOSURE

Warehouse that can burn

EVENT

Fire occurs

IMPACT

Losses and business disruption

The framework forces clarity: where does risk come from, what could happen, and what objective is affected?

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SECTION 2

Objectives Are the Anchor

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OBJECTIVES

Financial

Operational

Compliance

Reputation

Shariah

A risk only matters because it affects an objective.

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SECTION 2

Exercise: Garuda Indonesia Losses in 2021

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Using the risk framework, analyze the losses through four lenses:

SOURCE OF RISK

What triggered the exposure?

RISK FACTOR

What conditions increased probability?

RISK EVENT

What actually happened?

IMPACT

How did it affect objectives?

Group task: produce a short risk map, not a full case study.

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Why Risk Management Matters

Major failures show how unmanaged risk can destroy even sophisticated institutions.

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SECTION 3

The Importance of Risk Management

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Losses can arise from many sources: operations, strategy, technology, markets, regulation and reputation.

Risk management is the discipline that prevents surprise from becoming crisis.

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SECTION 3

Classic Failure Cases

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BARINGS BANK

A historic bank collapsed because of unmanaged trading losses and weak controls.

ENRON

Accounting manipulation and governance failure destroyed a major energy company.

LTCM

Even Nobel-level financial models failed under extreme market stress.

Key lesson: reputation, age and technical expertise do not replace governance and control.

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SECTION 3

Risk Failure Is Often a Culture Failure

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NO CHALLENGE

Bad decisions go unquestioned.

WEAK CONTROL

Exceptions become normal.

POOR REPORTING

Signals are ignored or delayed.

INCENTIVE MISALIGNMENT

People are rewarded for risk-taking without accountability.

Good risk management is not only a model. It is a behavior system.

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Risk Management Process

From identification to reporting, control and continuous improvement.

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SECTION 4

Overview of the Risk Management Process

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IDENTIFY

Potential risks

→

ASSESS & MEASURE

Probability and impact

→

PREVENT & MITIGATE

Reduce likelihood or damage

→

MONITOR

Track whether risk is managed

→

REPORT & CONTROL

Inform stakeholders and correct

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SECTION 4

What Each Step Does

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Risk Identification

Identify potential risks that may occur.

Risk Assessment & Measurement

Assess probability, estimate impact and quantify potential damage.

Risk Prevention & Mitigation

Apply strategies to prevent events or minimize damage.

Risk Monitoring

Oversee whether risks are being prevented or mitigated.

Risk Reporting & Control

Provide information and trigger corrective action.

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SECTION 4

Risk Management Approaches

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Top-down and bottom-up perspectives must meet.

Board and senior management set appetite, policies and priorities.

Business units see operational realities and early warning signals.

Effective risk management links strategy, execution and control.

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Risk Identification

A practical starting point for Islamic bank risk management.

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SECTION 5

Risk Identification: Key Risk Types

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Credit

Market

Equity Investment

Interest Rate / Rate of Return

Operational

Strategic

Technology

Regulatory

Liquidity

Shariah Non-Compliance

Islamic banks share many risks with conventional banks — but their contracts, governance and Shariah obligations change the risk profile.

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SECTION 5

Core Financial Risks

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CREDIT RISK

Counterparty is unable to fulfil its obligation.

MARKET RISK

Asset prices move opposite to expectation.

LIQUIDITY RISK

Bank lacks sufficient cash to meet withdrawals.

EQUITY INVESTMENT RISK

Investment value declines or losses arise from various factors.

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SECTION 5

Operational, Strategic and External Risks

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OPERATIONAL

Losses due to people, process, system or external event failure.

STRATEGIC

Losses due to strategic failure.

TECHNOLOGY

Losses due to changes or failures in technology.

REGULATORY

Losses due to regulatory changes or non-compliance.

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SECTION 5

Shariah Non-Compliance Risk

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Possible losses or opportunity losses when an Islamic financial institution fails to meet Shariah compliance requirements.

Invalid contracts or structures

Income purification needs

Reputation damage among Muslim customers

Regulatory and governance consequences

Loss of trust in the Islamic banking proposition

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SECTION 5

Pre-Requisites for Risk Identification

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Business objectives

Business plan

Industry context

Business process

Projected financial statements

Resources and capacity

Change management

Compliance system

You cannot identify risk properly without understanding how the business is supposed to work.

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SECTION 5

Tips for Risk Identification

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Define the target or objective first.

Identify challenges that may prevent the objective from being achieved.

List unexpected events from rare to frequent.

Analyze market, legal, social, political and environmental drivers.

Connect each risk event to its potential impact.

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SECTION 5

Techniques for Risk Identification

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Risk Checklist

Structured list of known risks.

Gap Analysis

Compare current state vs desired controls.

Risk Taxonomy

Classify risks using a standard hierarchy.

PEST Prompt

Political, Economic, Social and Technological scan.

SWOT Analysis

Strength, weakness, opportunity and threat review.

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PRACTICE

Exercise: Identify Risks Faced by These Institutions

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Pick one institution. Identify at least five risks, then classify each risk by source, event and impact.

Use: risk type • cause/factor • risk event • impact • preliminary control.

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PRACTICE

Exercise: Compare Across Institutions

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Different institutions face different risk profiles. Compare your answers across groups.

Which risks are common across all institutions?

Which risks are unique to Islamic financial institutions?

Which risk should be prioritized first — and why?

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WRAP-UP

Week 1 Key Takeaways

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Risk is the effect of uncertainty on objectives.

Risk analysis requires separating causes, events and impacts.

Risk management prevents surprise from becoming crisis.

The process moves from identification to reporting and control.

Islamic banks require special attention to Shariah non-compliance risk.

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WEEK 1 COMPLETE

Risk management begins with a clear understanding of objectives, uncertainty and impact.

NEXT → Applying the process to Islamic banking risk cases

Credit • Market • Liquidity • Operational • Shariah Non-Compliance

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