Posted on: 05/06/2009 

Moody’s Investors Service identified various characteristics found in strategies adopted by Islamic banks which enhance their financial strength ratings in a new report.

These include strategies that improve franchise value, risk positioning and financial fundamentals.
“While Islamic banks in different countries operate under different environments, are at different stages of development and therefore require different strategies, we can still find a set of common characteristics among their various strategies which benefit their long-term ratings,” said Christine Kuo, a Moody’s vice president/senior analyst and author of the report.
“Most Islamic banks’ strategies try to achieve asset growth. While this is important, appropriate systems and infrastructure to address risk issues need to be in place to support sustainable growth; therefore, risk
management should be implemented first followed by growth,” Kuo said.
“When it comes to global comparisons, it is more important for Islamic banks to build strong franchises in selective markets and businesses, and to maintain sound financial profiles as opposed to big balance sheets,” Kuo added.
The report assess strategies adopted not just by Islamic Financial Institutions (“IFIs”), whose scope of business must comply with Shariah Law, but also conventional banks which operate Shariah-compliant departments.
According to the report, while size is important because diversification is harder when an institution is small, those banks which enjoy dominant positions in smaller but more favorable markets may have a higher franchise value (which could translate into greater earnings stability) than a bigger bank with a highly price-sensitive customer base operating in a competitive market.
“It follows that it is better for Islamic banks to have a strategy that helps achieve a stronger position in a few selective markets than one which results in marginal positions in many competitive markets,” Kuo further said.
The report noted that Islamic banks tend to have greater concentration in assets and liabilities compared with conventional banks, and face challenges in managing liquidity and risk due to the limited range of instruments available.
Moreover, Islamic products are less commoditized and require more tailoring and oversight leading to substantial overheads and operation risk, the report noted.
“Additionally, for Islamic banks with significant exposures to equities and properties, conservative financial leverage is particularly important in view of the volatility in the values of these investments.”