Banking is a game that has been played for ages, some play it like chess where it is all about the king, his castle(s) and his followers; others play something like blackjack or roulette. Some play by the rules and others seem to just make their own rules. In reality it is all about taking risk for reward, but sadly every now-and-then one player goes well beyond their appetite for risk, sometimes without even knowing it.
Lately a few banks have even changed the rules of the game and opened a “window” with a focus on ethics and religion; whilst others want that so much that they changed the whole “building” to be an Islamic Bank.
Coming out of the global crisis; the game of banking is a tough game, but the rewards are still great. How about a recent advert talking about not waiting any longer to build up loyalty points to get rewards; it says something like “We give you free air-tickets as soon as you transfer your salary and take a XYZ-Bank credit card”
What that all really means is: We know that if we fly you to a place you could not afford to buy the tickets for, with a brand new credit card in your pocket, after you issued an instruction for us to get your salary; we pretty much have an income for life. When you return from that holiday you will enter the cycle where we will gladly take your salary every month. A large chunk of that will go to our “fees and interest income” account and the rest we will keep as a down-payment on your ever-increasing credit card debt. In case we do not need all of your salary for that, we will encourage you through consistent phone calls to buy a new car or go on an even more exotic vacation; in short: we will do almost anything just to keep your whole salary.
The “street-view” of Islamic Banking paints a different picture. Banking is banking and all banks make profits on some deals and losses on other deals, but I have yet to hear of an example where the loss from such a partnership-deal was shared between an Islamic Bank and its customer. Without such examples, the only logical conclusion is that the fundamental PLS- system is not always followed.
As a two friends put it in one of the best books I have ever read on Islamic Finance:* ”Conventional banking, largely based on interest, is characterized by non-participation of contracting parties in the profits and losses resulting out of the fulfillment of contracts” They continue to explain profit and loss contracts: “Islamic banking is dominated by Profit and Loss Sharing (PLS). It primarily promotes PLS between the lender and the borrower by converting their relationship of borrower and lender to partners. Islamic financial institutions are facing credit, operational, market and liquidity risks of a higher degree, mainly because of PLS.”
Looking at the higher degree of risk, it means that customers making very large deals, should do a risk assessment of their partner (the bank), covering all the aspects of credit, operational, market and liquidity risk assessment, control and optimization. Risk management in Islamic Finance goes both-ways; very much a case of reaching a level of convergence of a customer risk appetite with the bank’s risk appetite. History reflects that no bank really had a grip on their true appetite for risk, so the question for the future is plainly: What is your Risk Appetite?
Building an effective risk culture in a conventional bank is a difficult task, doing this in an Islamic institution is even more challenging when you add the customer as a partner and everything they do having to be confirmed as being in compliance with Sharia Law.
Two key components of an effective risk culture are Ethics and Conviction; honest business deals by people doing the right thing because they want to, not because they have to. Bob Diamond apparently said in a speech in 2011:”For me the evidence of culture is how people behave when no one is watching” No longer so clear in the historic testimony before a British parliamentary committee the following year: “The other guys were cheating, too, so we had no choice. A number of banks were posting rates that were significantly below ours that we didn’t think were correct”
In this space of Ethics, Conviction and Sharia Law, another part of the “street-view” is the way Conventional banks are passing such products through an Islamic window and the question of what actually happens inside that building. How thick are the internal walls separating these two very different business operations; the conventional bank where the winner takes it all, and the ethical and religious window where we share equally in the good and in the bad times?
As both Conventional and Islamic banks struggle to re-build corporate trust and follow ethical business principles, we will see the future of Risk Management developing into Risk Management through People, at the end of the game; it is all about the relationship that was built and the way forward, if there is a way forward.
Do banks really know and define how much risk they want to take? Are Relationship Managers really building long-lasting relationships or are we heading back to the days when they just “happened to be there” when the deal was done?
When we push ethics and religion to the front of banking, one question comes to mind: Where is the line in the sand for people who are getting paid to confirm compliance? Should it not just be a case of conviction that we are doing the right thing?
There are many lessons to be learned from the banking games of the past, but the industry is finally waking up to the people side of Risk Management.
The one answer to most of these challenges is: Building an effective Risk Culture where greed and compliance are replaced with honesty and conviction. A culture where each and every employee is committed to driving value and sustainability within a well-defined and communicated Risk Appetite is the only way forward.
As an old African Proverb says: “If you want to go fast, go alone; if you want to go far, go together”
*Financial Risk Management for Islamic Banking and Finance, Ionnis Akkizidis and Sunil Kumar Khandelwal, Palgrave McMillan, 2008
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