Introduction: Information, Risks, and Capital Financial intermediation is a critical factor for growth and corporate inclusion. two of its core functions is to mobilize financial resources from surplus agents and channel them to those with deficits. It thus allows investor entrepreneurs to expand economic activity and employment opportunities. It also enables household consumers, micro- and tiny entrepreneurs to expand their own welfare and earnings opportunities, and seek to smooth their lifetime outlays. In all cases, financial intermediation drives economic growth and contributes to corporate inclusion, provided it is conducted in a sound and efficient way.[1]
A financial intermediary's ability to process details on risks and returns of investment opportunities shall hold a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process details through institutions or markets, and have generally evolved from the former to the latter. In most cases, markets and agents give alternative ways of processing details on risks and returns of investment opportunities. Within first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally fewer liquid assets. Within the 2nd form, surplus agents purchase directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In neither approach, most categories of agents engage in transactions on the basis of trust and of expectations related to the degree of liquidity that should give the option to re-contract at a reasonable cost.[2] Within the case of banks, the trust should be seen as based on proprietary information. Within the case of markets, the details is more commoditized and widely available.[3]
Efficiently processed details can help the efficient allocation of capital. It can help a financial intermediary to better define the capital it should need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that shall endanger its stability. Banks engage in gathering and processing details on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank's investors and clients can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets should possibly convey similar sense of access to liquidity and stability based on disclosed and broadly available details on market participants. Markets can give deficit and surplus agents a direct role in processing details to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts compression on single agents to use capital at their disposal efficiently, and conclusions in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process details on risks and returns of investment opportunities while complying with Shari'ah principles.[5] Thus, in principle, they should be expected to increase competition in financial details processing by inducing better risk management and capital use. Such competition should be expected over time to lead to an efficient use of capital at the position of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide throughout all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At similar time, Islamic financial intermediation wants to comply with Shari'ah principles, notably those of risk sharing and materiality of financial transactions. Shari'ah compliance, corporate responsibility, and the discipline of competition compound IIFSs' challenge to process details efficiently sequential to manage the risks they shall face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the details and skills that can let them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices within the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs should invest within the collection of loss details and adoption of loss data management systems. IIFSs should benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 3 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 5 discusses regulatory and economic capital, introducing risk occurrence frequency like a distribution probability. Section six concludes with suggestions on steps that shall help with risk management and improve the competitiveness of IIFSs. 2. Bank Capital and Risk Management Bank capital should be considered as consisting of (a) equity capital and (b) sure non-deposit liabilities or debt capital (see Section 4). It is most a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is component of a bank's funding that should be applied directly to the purchase of earning assets, as well as being used like a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Most financial intermediaries and regulators are sensitive to the dual role of capital, like a means of funding earnings-generating assets and like a cushion for dealing with unanticipated events. Financial intermediaries shall tend to be more focused on the former role and regulators on the latter.
A bank's capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, should be influenced by its ability to calibrate the position of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can greatest help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) hold a constructive dialogue with regulators.
Efficient use of capital shall help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag below performance, endanger stability, or both. Equally, leaving capital idle entails at greatest forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile shall not let them neither to obtain the full potential of their capital or to contribute effectively to the development regarding the communities they serve. At the other end regarding the spectrum, a financial intermediary overly eager to achieve returns shall allocate resources to highly risky assets that release high returns but endanger stability. Explicit risk management practices can help within the selection of assets to which capital and other resources are applied and calibrate the position of capital that greatest suits business objectives and stability tolerance.
The volume and composition regarding the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full details is available and markets are complete, the value of a firm should be independent of its capital structure, and so the focus should be on capital position and not structure.[6] Below such circumstances, the method by which a financial intermediary raises its required funds should be irrelevant. However, financial intermediaries not ever operate in a frictionless world; they face imperfections for example costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to give a safety net. In fact, one shall contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary's position of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary's ability to assess not homecare insurance of capital it should need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets' reactions to perceptions of a financial intermediary's business conduct and capital strength should be unforgiving. It is thus within the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market's perception of market imperfections is likely to influence views on the appropriate position of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net shall lead market participants to be fewer demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders shall induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets shall expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank shall likely skills development a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum no. of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets should hold a higher no. of capital than those banks with fewer risky assets. However, fearing the harshness of market discipline, many banks maintain a higher position of capital than the minimum required to allay the perception that they should be undercapitalized and stay away from the losses this shall induce, as witnessed within the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations within the bank's earnings and supports higher assets growth.
Finally, efficient risk management should let financial intermediaries to hold a constructive dialogue with regulators. It should help them to articulate their views with respect to capital needs. The regulators' rationale for regulating capital stems from the perception regarding the public-good nature of bank services, their potential macroeconomic growth and stability impact, and skills development with costly bank failures. Regarding to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators' concerns with likely systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks' capital.[8] Regulators' concerns should be compounded by the presence of deposit insurance schemes. The moral hazard that shall result from deposit insurance shall lead to additional regulatory requirements for example linking the position of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance shall induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices should let banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators should generally also be concerned with the overall impact on the economy regarding the resources raised by the financial system below their purview. From an economy-wide perspective, banks should be viewed as firms' competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting like a buffer against future losses, thereby reducing excessive risk receiving regarding the banks. At similar time, raising bank capital shall lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets shall increase the cost of banks' resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher position of equity shall actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can give inputs to most banks and regulators to better calibrate capital wants and deal with the foregoing kind of tradeoff.
The position of a financial intermediary's capital shall also hold a bearing on its ability to give liquidity. The financial intermediary provides liquidity by funding assets that should be fewer liquid than the deposit resources it collects. There is a view that requirements for higher grades of capital shall hold a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement shall lead to a corresponding reduction within the position of deposits, thus constraining the ability to give liquidity. Also, higher capital requirements shall induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to give liquidity. However, regarding to another view, higher capital should let the financial intermediary to make more liquidity since its risk-absorptive capacity should be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for tiny banks this effect is negative.[11] Accordingly, each financial intermediary should need to evaluate carefully the position and composition regarding the capital it needs, since the latter plays a significant role in its ability to function like a liquidity provider. Equally, regulators should need to pay attention to the impact which capital requirement should have on the funding regarding the economy.
IIFS's risk management arrangements shall bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS's characteristic of mobilizing funds within the shape of risk-sharing investment accounts in location of conventional deposits, together with the materiality[12] of financing transactions, shall alter the overall risk regarding the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing "deposits" should in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and hold a bearing on the assessment for the overall need for capital; asset-based modes of finance should be fewer risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs should operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to place in location risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari'ah, their own mission statements, and the protection of their stakeholders. [1] Look Honohan (2004) and Levine (2004).
[2] Sir Paul Hicks identifies such liquidity as one regarding the first factors behind the Industrial Revolution.
[3] Actually, a deposit should be viewed like a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected within the trends of their relative market shares of total financial assets. For example, within the United States, between 1960 and the early 1990s, commercial banks' share of total financial intermediaries' assets fell from around 40% to fewer than 30%. Look Edwards (1996).
[5] They do respond to a latent demand for financial services that not ever breach Shari'ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and corporate inclusion. Look also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] Look Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; look Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the "materiality" of financing transactions is meant that, in such transactions, capital should be "materialized" within the shape of an asset or asset services (as in Murabaha credit sales, Salam and Istisna'a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital within the shape of money is not entitled to any return, as this should be interest (riba).
Introduction: Information, Risks, and Capital Financial intermediation is a critical factor for growth and corporate inclusion. two of its core functions is to mobilize financial resources from surplus agents and channel them to those with deficits. It thus allows investor entrepreneurs to expand economic activity and employment opportunities. It also enables household consumers, micro- and tiny entrepreneurs to expand their own welfare and earnings opportunities, and seek to smooth their lifetime outlays. In all cases, financial intermediation drives economic growth and contributes to corporate inclusion, provided it is conducted in a sound and efficient way.[1]
A financial intermediary's ability to process details on risks and returns of investment opportunities shall hold a bearing on the soundness and efficiency of its resource mobilization and reallocation function. Conventional financial services (CFSs) process details through institutions or markets, and have generally evolved from the former to the latter. In most cases, markets and agents give alternative ways of processing details on risks and returns of investment opportunities. Within first form, the intermediary raises capital to set up business to collect generally liquid deposits from surplus agents and reallocates these resources, now in his trust, to ones with deficits in generally fewer liquid assets. Within the 2nd form, surplus agents purchase directly financial assets that represent a debt of a deficit agent or an ownership share in its business. In neither approach, most categories of agents engage in transactions on the basis of trust and of expectations related to the degree of liquidity that should give the option to re-contract at a reasonable cost.[2] Within the case of banks, the trust should be seen as based on proprietary information. Within the case of markets, the details is more commoditized and widely available.[3]
Efficiently processed details can help the efficient allocation of capital. It can help a financial intermediary to better define the capital it should need to achieve the returns sought, while maintaining its ability to face the financial consequences of unexpected events that shall endanger its stability. Banks engage in gathering and processing details on clients and markets, which allows them to manage different risks by unbundling them and reallocating the components. By performing these services soundly and efficiently, banks can manage to calibrate their capital requirements and receive diversified income streams. Thus a bank's investors and clients can gain comfort as to its reliability in allowing them to access liquidity and maintain stability. In parallel with banks, financial markets should possibly convey similar sense of access to liquidity and stability based on disclosed and broadly available details on market participants. Markets can give deficit and surplus agents a direct role in processing details to facilitate the unbundling and reallocation of risks and the efficient use of capital. Thus, banks and markets compete and complement each other in financial intermediation. The competition puts compression on single agents to use capital at their disposal efficiently, and conclusions in a system-wide improved allocation of capital resources.[4]
Institutions offering Islamic financial services (IIFSs) also process details on risks and returns of investment opportunities while complying with Shari'ah principles.[5] Thus, in principle, they should be expected to increase competition in financial details processing by inducing better risk management and capital use. Such competition should be expected over time to lead to an efficient use of capital at the position of each financial agent, whether they practice conventional or Islamic finance, and in aggregate, system-wide throughout all modes of financial intermediation. Efficient use of capital is thus a challenge which competition imposes on all financial intermediaries, whether offering Islamic financial services or conventional financial services. At similar time, Islamic financial intermediation wants to comply with Shari'ah principles, notably those of risk sharing and materiality of financial transactions. Shari'ah compliance, corporate responsibility, and the discipline of competition compound IIFSs' challenge to process details efficiently sequential to manage the risks they shall face and use their capital endowments. Thus, by their very nature and the environment in which they generally operate, IIFSs need to be well equipped with the details and skills that can let them to identify their capital resources and use them efficiently.
This chapter argues for the need for Islamic financial services to strengthen risk management practices within the process of defining their own capital requirements in accordance with their loss tolerance. It suggests that IIFSs should invest within the collection of loss details and adoption of loss data management systems. IIFSs should benefit from implementing risk management methodologies and adapting their staffing skills accordingly. The chapter starts in Section 3 by outlining views on the relationship between risk management and capital for financial intermediation. It then overviews risk categories as an initial step in risk management in Section 3. Section 5 discusses regulatory and economic capital, introducing risk occurrence frequency like a distribution probability. Section six concludes with suggestions on steps that shall help with risk management and improve the competitiveness of IIFSs. 2. Bank Capital and Risk Management Bank capital should be considered as consisting of (a) equity capital and (b) sure non-deposit liabilities or debt capital (see Section 4). It is most a means of funding earnings-generating assets and a stability cushion. From the perspective of efficiency and returns, capital is component of a bank's funding that should be applied directly to the purchase of earning assets, as well as being used like a basis for leverage to raise other funds for expanding assets with the net benefit accruing to shareholders. From a perspective of stability, bank capital is a cushion for absorbing shocks of business losses and maintaining solvency, with benefits accruing to depositors and other stakeholders. Most financial intermediaries and regulators are sensitive to the dual role of capital, like a means of funding earnings-generating assets and like a cushion for dealing with unanticipated events. Financial intermediaries shall tend to be more focused on the former role and regulators on the latter.
A bank's capital structure decision relates to the ratio of capital to deposits and to the ratio of debt capital to equity capital. Its performance, in terms of return on equity capital, should be influenced by its ability to calibrate the position of capital it requires. Through efficient risk management, it can reach a sense of which capital structure can greatest help it to: (a) achieve profitability while maintaining stability; (b) reassure markets as to the quality of its business conduct; and (c) hold a constructive dialogue with regulators.
Efficient use of capital shall help IIFSs to achieve profitability and stability. Allocating capital resources to low-performing or excessively risky assets is bound to drag below performance, endanger stability, or both. Equally, leaving capital idle entails at greatest forgoing earnings opportunities. For instance, overly cautious approaches that lead financial intermediaries to maintain larger amounts of capital than warranted by their risk profile shall not let them neither to obtain the full potential of their capital or to contribute effectively to the development regarding the communities they serve. At the other end regarding the spectrum, a financial intermediary overly eager to achieve returns shall allocate resources to highly risky assets that release high returns but endanger stability. Explicit risk management practices can help within the selection of assets to which capital and other resources are applied and calibrate the position of capital that greatest suits business objectives and stability tolerance.
The volume and composition regarding the resources that capital enables financial intermediaries to raise are likely to affect their profitability and stability. In a frictionless world where full details is available and markets are complete, the value of a firm should be independent of its capital structure, and so the focus should be on capital position and not structure.[6] Below such circumstances, the method by which a financial intermediary raises its required funds should be irrelevant. However, financial intermediaries not ever operate in a frictionless world; they face imperfections for example costs of bankruptcy and financial distress, transaction costs, asymmetric information, or taxes. They also operate within the framework of a governing regulation possibly with a deposit insurance scheme that is expected to give a safety net. In fact, one shall contend that these market imperfections are the very reason for the successful existence of banks as financial intermediaries. Accordingly, not only a financial intermediary's position of capital but also its structure is likely to bear on its market valuation, its business conduct, and its stability. Effective risk management strategies should contribute to a financial intermediary's ability to assess not only the position of capital it should need in relation to assets and deposits, but also the extent to which its structure affects its value.
Market discipline contributes to responsible corporate behavior. Markets' reactions to perceptions of a financial intermediary's business conduct and capital strength should be unforgiving. It is thus within the interest of financial intermediaries to develop approaches to defining capital resource requirements that take into account the institutional environment in which they operate. The market's perception of market imperfections is likely to influence views on the appropriate position of capital and the capital adequacy of financial intermediaries. For example, the availability of a safety net shall lead market participants to be fewer demanding as to the need for capital in relation to bank assets. Conversely, anticipation of high costs of financial distress to depositors and other stakeholders shall induce market participants to require the holding of more capital proportionally to assets. Similarly, wherever the institutional environment is weak and contract enforcement is uncertain and costly, markets shall expect financial intermediaries to adapt the capital they hold.
The management of capital structure should in principle mitigate the risk of bank failures. When comparing a highly leveraged bank and a bank that is well capitalized, the leveraged bank shall likely skills development a greater loss of value during times of financial distress when the asset quality deteriorates, due to the increased risk of bankruptcy. To cope with downturns, in most countries banks hold a minimum no. of capital, based on the risk embedded in their asset holding. Accordingly, banks with relatively risky assets should hold a higher no. of capital than those banks with fewer risky assets. However, fearing the harshness of market discipline, many banks maintain a higher position of capital than the minimum required to allay the perception that they should be undercapitalized and stay away from the losses this shall induce, as witnessed within the 1980s. The key capital adequacy ratio provides an assessment of just how adequately the capital cushions such fluctuations within the bank's earnings and supports higher assets growth.
Finally, efficient risk management should let financial intermediaries to hold a constructive dialogue with regulators. It should help them to articulate their views with respect to capital needs. The regulators' rationale for regulating capital stems from the perception regarding the public-good nature of bank services, their potential macroeconomic growth and stability impact, and skills development with costly bank failures. Regarding to some estimates, such costs have varied between 3% and 55% of GDP.[7] Thus, regulators' concerns with likely systemic risk resulting from the contagion effects of bank runs lead them to seek to mitigate risks of financial distress with regulatory requirements on banks' capital.[8] Regulators' concerns should be compounded by the presence of deposit insurance schemes. The moral hazard that shall result from deposit insurance shall lead to additional regulatory requirements for example linking the position of insurance premia to the risk embedded in assets and captured in associated risk weights. Indeed, deposit insurance shall induce banks to lever up capital by expanding their own funding with liabilities, thus placing more risk on their capital and increasing their vulnerability. Efficient risk management practices should let banks to improve their dialogue with the regulator and convey more convincingly their views on their soundness and capital requirements.
Regulators should generally also be concerned with the overall impact on the economy regarding the resources raised by the financial system below their purview. From an economy-wide perspective, banks should be viewed as firms' competitors in raising capital on financial markets. The outcome of this competition has a bearing on economic performance and financial stability, and points to a cost–benefit tradeoff in holding capital. For instance, Gersbach (2007) suggests that a benefit of bank capital is the equity acting like a buffer against future losses, thereby reducing excessive risk receiving regarding the banks. At similar time, raising bank capital shall lead to a crowding out of industrial firms, limiting their access to equity and other market funding and also impacting their access to funding from banks and its cost. Furthermore, raising equity on markets shall increase the cost of banks' resources, inducing them to seek to invest in higher-yielding but more risky assets and thereby increasing their risk exposure. Thus, while potentially providing a cushion against unforeseen events, a higher position of equity shall actually induce more risk taking, notably through raising the cost of funds to banks and their clients. Efficient risk management can give inputs to most banks and regulators to better calibrate capital wants and deal with the foregoing kind of tradeoff.
The position of a financial intermediary's capital shall also hold a bearing on its ability to give liquidity. The financial intermediary provides liquidity by funding assets that should be fewer liquid than the deposit resources it collects. There is a view that requirements for higher grades of capital shall hold a negative impact on liquidity creation.[9] On the liability side, a higher capital requirement shall lead to a corresponding reduction within the position of deposits, thus constraining the ability to give liquidity. Also, higher capital requirements shall induce financial intermediaries to be more restrained in extending financing, thus constraining their ability to give liquidity. However, regarding to another view, higher capital should let the financial intermediary to make more liquidity since its risk-absorptive capacity should be improved.[10] In this regard, an empirical study concluded that for larger banks capital has a statistically significant positive net effect on liquidity creation, while for tiny banks this effect is negative.[11] Accordingly, each financial intermediary should need to evaluate carefully the position and composition regarding the capital it needs, since the latter plays a significant role in its ability to function like a liquidity provider. Equally, regulators should need to pay attention to the impact which capital requirement should have on the funding regarding the economy.
IIFS's risk management arrangements shall bear on their ability to calibrate capital to their business objectives and risk tolerance, to deal with market discipline, and to maintain a dialogue with regulators. The IIFS's characteristic of mobilizing funds within the shape of risk-sharing investment accounts in location of conventional deposits, together with the materiality[12] of financing transactions, shall alter the overall risk regarding the balance sheet and, consequently, the assessment of their capital requirements. Indeed, risk-sharing "deposits" should in principle reduce the need for a safety cushion to weather adverse investment outcomes. Similarly, the materiality of investments is likely to modify the extent of their risk and hold a bearing on the assessment for the overall need for capital; asset-based modes of finance should be fewer risky and profit-sharing modes more risky, than conventional interest-bearing modes. Nevertheless, IIFSs should operate within a regulatory framework that is likely to impose on them capital requirements with a view to promoting stability and limiting contagion risks. However, besides regulatory and market demands for IIFSs to hold capital, IIFSs need to place in location risk management assessments for their own purposes of returns and stability in accordance with the requirements of Shari'ah, their own mission statements, and the protection of their stakeholders. [1] Look Honohan (2004) and Levine (2004).
[2] Sir Paul Hicks identifies such liquidity as one regarding the first factors behind the Industrial Revolution.
[3] Actually, a deposit should be viewed like a purchase of a debt asset issued by the intermediary and redeemable at its face value.
[4] The institution–market competition is reflected within the trends of their relative market shares of total financial assets. For example, within the United States, between 1960 and the early 1990s, commercial banks' share of total financial intermediaries' assets fell from around 40% to fewer than 30%. Look Edwards (1996).
[5] They do respond to a latent demand for financial services that not ever breach Shari'ah principles. Accordingly, they have the potential to contribute to financial deepening, economic growth, and corporate inclusion. Look also Burghardt and Fuss (2004).
[6] Modigliani and Miller (1958).
[7] Look Klingebiel and Laeven (2007).
[8] Views differ on the need for and extent of regulation, as well as on the usefulness of deposit insurance; look Barth, Caprio, and Levine (2007).
[9] Diamond and Rajan (2006).
[10] Allen and Gale (2007).
[11] Berger and Bouwman (2005).
[12] By the "materiality" of financing transactions is meant that, in such transactions, capital should be "materialized" within the shape of an asset or asset services (as in Murabaha credit sales, Salam and Istisna'a financing, or Ijarah leasing), or of a business venture (Musharakah or Mudarabah). Capital within the shape of money is not entitled to any return, as this should be interest (riba).
...... to be Cont.
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